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Opalesque Islamic Finance Intelligence

Lex Islamicus: Universality and Codification of Islamic Contracts By Khalil Jarrar, J.D.

Wednesday, March 17, 2010

New Page 1

 Khalil has a diverse educational and professional experience in both Information Technology and International Law. Working as a senior IT consultant for a range of multi-national corporations, he holds a law degree from the US (J.D.) in addition to International Law training at the Hague Academy and Strasbourg International Institute of Human Rights. He is a Bi-lingual and Bi-Cultural Arab-American with extensive knowledge of the MENA region. Khalil currently hold a position as an International law consultant for a Geneva based foundation.

One of the most notable challenges facing the enforcement of Islamic contracts (in particular in the context of Europe and North America) has been the lack of a clear reference to a state law. Earlier references to Islamic jurisprudence have been repeatedly rejected in US courts, these references being to Islamic law at large. The courts have indicated that they lacked sufficient knowledge of the subject matter so as to render judgment, even with the help of an expert witness (such as a scholar).

Freedom of contracts is a universally accepted principle if the contract provisions are clear and definitive, however the challenge arises if and when contract contract clauses make a generic reference to Islamic or Shari’a law. In other words there is not enough clarity regarding which laws, regulations or standards which are to be followed. Furthermore, how can it be expected for foreign courts to rendered judgment based on Islamic law when inconsistencies between Islamic countries applying such law have also arisen? An example that comes to mind is the sale of discounted debt instruments. Malaysia on one hand allows for the sale of discounted coupons where this view is completely rejected by Islamic jurists in the Arab Gulf states.

Sources of law can be traced to various religions or customs but this has since been incorporated into state and/or international law, and example of this being Lex mercatoria or the law of merchants (see reference link). The Lex mercatoria was composed of such usages and customs as were common to merchants and traders in all parts of Europe, and these varied slightly in different localities by special peculiarities (refer to this paper for a history of the development of Lex Mercatoria as it relates to international business law).

The same could be said about the application of Islamic law today where the combination of custom and usage, urf, has played a major role in shaping modern Islamic law among the major Madhahib of Islam. Shari’a is the larger all-encompassing umbrella that could include more than one school of thought, even calling on expert witnesses could create issues of bias or lack of knowledge of that particular school of thought or Madhab.

Conflicts of laws have a tendency to arise under private international law when a partial reference to a specific state law is used, leaving the burden to another court (in a different forum) to adjudicate, interpret or enforce such a contract. The Rome Convention under EU law (see reference link) allows for partial choice of law, however according to prevailing legal view the dual choice of law can only be applied to specific and clearly defined parts of a contract, due to the requirements of certainty. Specifically, this will govern:

a. Interpretation

b. Performance, with reference to lex loci solutionis (law of the place in which performance takes place)

c. Consequences of breach, including the assessment of damages

d. Ways of extinguishing obligations (and the limitation of actions)

e. Consequences of nullity of the contract

One way to achieve acceptability of Islamic contracts is for of the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI) to play the same role as the UNIDROIT principles (see reference link) on international commercial contracts in addition to Lex mercatoria.

Thus far English courts have taken a strict stand to the application of Shari’a law. In a landmark decision, Shamil Bank of Bahrain EC vs. Beximco Pharmaceuticals Ltd., the English Court of Appeal has refused to enforce Shariah principles, based on three arguments:

1) The EU Rome Convention allows only the choice of State Law; so in order for an Islamic contract to be enforced in the England there must be a specific reference to a specific code of a sovereign state;

2) The court also asserted that a contract can only be construed under one single jurisdiction; meaning that the governing law has to exclusively reference to the law of a particular country; and finally,

3) it cannot be the parties' intention to entrust an English court with the interpretation of the Shari’a related principles.

The latter argument echoes earlier decision by the US court in a matrimonial dispute in the landmark case of Shaban v. Shaban, stating that parties cannot agree, without a premarital agreement as to basic terms, that a marriage will be governed by another country's laws and then fill in the basic terms by parol evidence, leaving the court with the burden of interpreting extrinsic evidence in accordance with Shari’a law.

In Germany, the prevailing view is that non-State law can be integrated into a contract by way of reference to substantive law instead of by way of choice of governing law. Hence the parties may agree to exercise or enforce their claims and other rights (under State Law) exclusively subject to compliance with the Shari'a rules. This view in my opinion takes us to square one, in other words what are Shari'a rules? According to what school of thought under Islamic law itself? To add another wrinkle to the issue at hand, the German financial services supervisor (BaFin) have advised that they would welcome Islamic Finance. However, major clarifications in respect of the tax regime seem to be necessary, in particular regarding real estate finance not using SPV structures, adding another layer of complexity to the task at hand for AAOIFI.

Notwithstanding the fact that Islamic financial instruments have gained popularity with an unmatched growth in a short period of time; this growth comes with a price to pay. To regain universality, Islamic contracts have to be codified, such codification can be traced to the Ottoman empire where it took the form of Al-Majalla code which is tangible proof that general principles of Islamic law do exist. It is incumbent upon major stakeholders in Islamic finance to assert such universality with incorporating major principles of Islamic contracts into state laws. This can be a concerted effort working with AAOIFI standards as it has reached common grounds of acceptable practices of sales contracts.

Leaving foreign courts with the discretion of interpreting such contracts will open the door for inconsistency of judgment. Uniformity of law is paramount especially in jurisdictions where precedent applies; rendering a judgment on the wrong legal foundation will create a domino effect of decisions to follow. Remedies for breach of contracts can be inconsistent as well opening another door for forum shopping. It is time to set the path for Uniform Islamic Sales contracts or a Uniform Islamic commercial code, or in the absence of such uniformity, adequate reference to a substantive law or state code should be made clear in drafting such contracts. Such practice is not only good for judicial economy, it is equitable as well in conformance with the principles of good faith in Islamic law.

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