This article discusses the resolution of Islamic banking and finance disputes in a modern world of dispute resolution, in which litigation and arbitration as the main contentious forms of dispute resolution contend for taking prime position before any other form of dispute resolution. Given the high degree of specialty required in the resolution of disputes arising from more modern financial products, arbitration has more recently moved to the fore in this area of practice. This trend has also been strengthened by an increased offering of Islamic finance products, which in turn has spurred the need for Shari’a-compliant dispute resolution.
In the following, this article will provide some background to dispute resolution in the banking and finance sector, highlighting in particular the apparent inaptitude of conventional dispute fora, such as the courts, to deal with Islamic finance disputes adequately. In further course, the article will address how arbitration as an alternative form of dispute resolution can assist in providing Shari’a-compliant solutions where conventional dispute resolution through the courts fails and in doing so, makes the case for semi-secular arbitration, a form of arbitration that combines Islamic and secular elements to ensure a Shari’a-compliant outcome.
Islamic Finance v. Conventional Banking
Islamic finance as an alternative to conventional banking and finance has grown exponentially over the past 2-3 decades. The Islamic finance market measures multiple trillions of USD today. It offers crisis-proof investment products that appeal to both Muslims and non-Muslims and have a significant non-Muslim take-up. Some jurisdictions (e.g. UAE, UK, France, Malaysia and Singapore) have been trying to attract Islamic finance investments on a grander scale, through adaptation of their banking facilities and by advertising themselves as global or regional centers for Islamic finance. Western jurisdictions in particular (e.g. UK/London and US/New York) have been trying to extend their existing dominance as a jurisdiction of choice for conventional banking disputes to disputes arising from Islamic finance products, English and New York law being the preferred governing law of international banking and finance contracts.
The Compliance Problem and the Shari’a Risk
Islamic finance products must be halal (i.e. permissible and in compliance with the Islamic Shari’a), as opposed to haram (i.e. prohibited). As such they must not violate prohibitions of riba (i.e. interest or excessive gain), gharar (i.e. uncertainty) and maysir (i.e., gambling or speculation) and are based on the axiom of profit and loss sharing. Standard products that are Shari’a-compliant include morabaha (cost-plus financing), mudaraba (trust financing) and ijara (leasing).
To preserve their compatibility with the Shari’a, Islamic finance products must comply with the basic Islamic law requirements and hence remain Shari’a-compliant over their entire life-cycle. To ensure compliance at the beginning of an investment cycle, Islamic finance contracts are routinely examined and approved as Shari’a-compliant by a corporate Shari’a board. The compliance requirement extends to any dispute resolution process that ensues from a dispute arising from an Islamic finance agreement in that both the process itself and the outcome must be Shari’a-compliant.
Non-compliance poses a Shari’a risk, i.e. the risk that one of the parties to the Islamic finance contract or the dispute arising from it argues the invalidity of the contract or dispute resolution process by virtue of its failure to comply with the Shari’a, a risk that is aggravated by the absence of a codified body of Islamic Shari’a. This, in turn, may raise enforcement issues with respect to:
- the disputed Islamic finance contract; or
- the resultant court judgment/arbitral award (where e.g. the enforcing court in the target jurisdiction equates a violation of the Islamic Shari’a to a violation of public policy), combined with a risk of nullification.
To mitigate the Shari’a risk, parties are free to contract into:
- Shari’a-compliant dispute resolution;
- a dispute resolution forum that is likely to comply with Shari’a law requirements (in both substance and form/procedure);
- an enforceable governing law clause that ensures application of the Islamic Shari’a; or
- a waiver of the Shari’a defense (albeit possibly not enforceable).
Litigating Islamic Finance Disputes: The Problem
Internationally, the courts of a few regionally and globally leading jurisdictions have been the common forum for dispute resolution for conventional banking and by extension for Islamic finance disputes. Historically, the London and New York courts have developed a reputation as neutral fora for conventional finance litigation, having built considerable expertise in the application of English and New York law to banking and finance disputes, but other than that these courts are Shari’a-inexperienced.
That said, even in Muslim jurisdictions, such as Malaysia, the civil courts are separate from the Shari’a courts and judges lack knowledge or specialism in the application of the Islamic Shari’a. Therefore, court litigation is unlikely to assist in managing the Shari’a risk responsibly: Both the English and the Malaysian courts have relied on English law and more specifically conventional banking practice in the interpretation of Islamic finance contracts. The English courts in particular have refused to give full effect to the enforcement of governing law clauses providing for the application of English law subject to the Islamic Shari’a.
The Governing Law Paradox: The English Law Example
On a number of occasions to date, the English courts have been asked to consider the scope of a governing law clause in an English law contract within an Islamic context and in particular whether it contained sufficiently precise wording to encompass the Islamic Shari’a. The courts’ findings on the subject have been diverse, some finding in favour of the incorporation of the Islamic Shari’a, others against.
By way of example, in Shamil Bank of Bahrain EC v. Beximco Pharmaceuticals Ltd., the English Court of Appeal held that a blanket reference to the Islamic Shari’a did not amount to the law of a country within the meaning of Arts 1.1 and 3.1 of the Rome Convention; on that basis, English law only applied to the underlying transaction (although the revised wording at Rectial 13, Rome I, may no longer support this concusion as it no longer refers to the “law of a country”, but more generically refers to “rules”). That said, principles of Islamic Shari’a could be incorporated provided a sufficiently precise reference (even though such a proposition poses challenges given the absence of a codified body of Islamic Shari’a).
By contrast, in Halpern v. Halpern, the English Court of Appeal recognised that parties can resort to a non-national system of law in arbitration. Finally, in The Investment Dar Company KSCC v. Blom Development Bank SAL, the Chancery Division of the English High Court examined Shari’a compliance of the underlying wikala contract and held it was Shari’a non-compliant. Evidently, Chancery judges, routinely dealing with principles of equity in English common law, are more familiar with and therefore accommodating of Shari’a as an applicable body of law.
Taking guidance in particular from the English courts’ approach in Halpern, arbitration may well be the solution to resolving Islamic finance disputes in a way that gives full effect to the Islamic Shari’a as the governing law.
The Solution: Arbitration
Importantly, the English courts recognise a blanket reference to the Islamic Shari’a as a body of rules that can be arbitrated (see Halpern v. Halpern). As such, the English courts have enforced an ICC award rendered by a Shari’a arbitrator in London and applying the Islamic Shari’a within the context of a governing law clause that provided for “the Law of England except to the extent that it may conflict with the Islamic Shari’ah, which shall prevail”) (see Sanghi Polyesters Ltd. (India) v. The International Investor KCFC (Kuwait)). Therefore, it is safe to say that arbitration allows a choice of a national law, and more specifically English law, in combination with the rules of the Islamic Shari’a, even as an undefined or unidentified body of law.
This position also stands confirmed by:
- Art. 1(2)(d) of the Rome Convention/Rome I, which contains an arbitration exemption and as such excludes the application of choice of law rules promulgated by Rome I to arbitration;
- s. 46(1)(b) of the 1996 English Arbitration Act, which empowers a tribunal to decide a dispute “in accordance with such other considerations as are agreed by [the parties] or determined by the tribunal” and hence endorses the contracting parties’ choice of the Islamic Shari’a as forming part of the body of law governing their agreement; and
- Art. 35(1) of the DIFC Arbitration Law, which empowers a tribunal to decide a dispute “in accordance with such rules of law as are chosen by the parties as applicable to the substance of the dispute” and hence accommodates a reference to the Islamic Shari’a as forming part of the rules of law chosen by the parties to govern the substance of their dispute.
The Arbitration Alternatives: Secular v. Islamic
The choice of arbitration offers a number of alternatives, some secular others Islamic in nature, thus facilitating the creation of a forum that can cater for the resolution of disputes in Islamic finance more specifically and not only in conventional banking. Following the secular/Islamic dichotomy, the following options come to mind:
- Secular: Choice of a conventional institution (e.g. ICC, LCIA, AAA); using a conventional set of international commercial arbitration rules of arbitration, such as the ICC, LCIA or AAA Rules; with seat London (England) or New York (US) as the traditional fora for conventional banking and finance disputes; and a tribunal with particular specialism in the banking and finance industry; and under a conventional governing law, such as English or New York law (following the example of contemporary complex banking and finance products), possibly excluding of the Islamic Shari’a or Shari’a defense expressly (following the example of the ISDA/IIFM Tahawwut (Hedging) Master Agreement).
This option excludes the non-compliance problem, but increases enforcement risk in Shari’a-compliant jurisdictions.
- Islamic: Choice of a specialist institution (e.g. IMAC, AIAC, IICRA) with a focus on Islamic financne disputes; using specialist sets of arbitration rules, such as the IMAC Shari’a Arbitration Rules, the AIAC i-Arbitration Rules (latter of which provide for a referral mechanism to Shari’a experts, late payment charges, and a technical review of draft awards to ensure Shari’a compliance), or the IICRA Arbitration Rules; with seat in Hong Kong, Kuala Lumpur or Dubai; and a tribunal with particular specialism in Islamic banking and finance; and under a governing law that expressly incorporates the Islamic Shari’a or that incorporates the Islamic Shari’a by definition (such as e.g. UAE law).
Conclusion: The Case for Semi-Secular Arbitration
Rather than settling for one or the other option, devoutly Shari’a or entirely secular, there is a viable alternative that combines the two in relevant part in order to ensure a Shari’a-compliant outcome: Semi-secular arbitration.
Semi-secular arbitration could take the following shape:
- Choice of a conventional arbitration centre located in the Middle East, e.g. DIAC or the DIFC-LCIA, with relevant experience in dealing with disputes of a Middle Eastern nature: The DIAC more specifically will provide “soft scrutiny” of a draft award to safeguard, inter alia, against public policy violation, such as Islamic Shari’a.
- In combination with regional arbitration rules, such as the DIAC or the DIFC-LCIA Rules, which facilitate, inter alia, the appointment of party- and/or tribunal-appointed experts, including ones that may assist in the assessment of issues regarding the Islamic Shari’a.
- Seated in the region, e.g. in Dubai or the DIFC: The DIFC Arbitration Law more specifically allows the application of “rules” of law, including for that matter the Islamic Shari’a.
- The tribunal may be specialist, with expertise in banking and finance: Where there is a three-member panel, it might be sufficient only for the chairperson to have Islamic finance experience or expertise. Ultimately, though, the burden of education rests on the disputing parties and the tribunal might be assisted by expert evidence on Islamic Shari’a.
- Choice of a secular law on the merits, but subject to Islamic Shari’a (such as UAE law, which incorporates references to the Islamic Shari’a) or with reference to precise Shari’a law principles, in order to ensure enforceability of the Shari’a component of the governing law provision. For the avoidance of doubt, even though a blanket reference will be sufficient, in order to eliminate risk, the reference should be specific.
This alternative, semi-secular option is likely to produce a Shari’a-compliant outcome by mitigating Shari’a risk.
In a global environment where Islamic finance products have come to the fore as an alternative product of investment that attracts Middle Eastern and Western investors alike, a form of semi-secular arbitration may assist the resolution of Islamic finance disputes without losing sight of the mandatory requirement for Shari’a compliance. Prosit!
 This article is based on G. Blanke, “Islamic banking and finance disputes: the case for semi-secular arbitration (Part 1)”, Practical Law Arbitration Blog, Thomson Reuters, 4 April 2019, available online at http://arbitrationblog.practicallaw.com/islamic-banking-and-finance-disputes-the-case-for-semi-secular-arbitration-part-1/; and G. Blanke, “Islamic banking and finance disputes: the case for semi-secular arbitration (Part 2)”, Practical Law Arbitration Blog, Thomson Reuters, 2nd May 2019, available online at http://arbitrationblog.practicallaw.com/islamic-banking-and-finance-disputes-the-case-for-semi-secular-arbitration-part-2/.
 E.g. Art. 37, Riyadh Convention; Art. 2, GCC Convention; and Art. V, New York Convention.
 Cf. in particular the availability of summary judgments and legal certainty, lowering credit risk for financial institutions.
 Whose competence is limited to family/status matters and disputes between Muslims.
 E.g. BKRM Bhd v. Emcee Corporation  CLJ 625). Federal Law No. 7 of 1975 regulating the Practice of Human Medicine.
  EWCH 2128 (Comm).
  EWCA Civ 29.
  EWCH 3545 (Ch).
 Cited supra.
  1 Lloyd’s Rep 480.
 1980 Rome Convention on the law applicable to contractual obligations, OJ C 027, 26/01/1998, pp. 34 – 46.
 Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I), OJ L 177, 4.7.2008, pp. 6–16.
 DIFC Law No. 1 of 2008.
 International Chamber of Commerce (International Court of Arbitration).
 London Court of International Arbitration.
 American Arbitration Association.
 A hedging master agreement produced by the International Swaps and Derivatives Association, Inc. (ISDA) in collaboration with the International Islamic Financial Market (IIFM).
 International Mediation and Arbitration Centre.
 Asian International Arbitration Centre.
 International Islamic Centre for Reconciliation and Arbitration.