Islamic financing agreements raise particular issues in the field of litigation and enforcement, in particular if borrowers invoke shariah principles to argue that an agreement was contrary to shariah law and is void as a consequence.
English courts have heard several cases and developed the general principle that a contract should be governed by the contractual agreement and applicable state law; they are not prepared to validate a choice of shariah law, inasmuch as it is “too vague.”
Banks have reacted to the spread of Islamic finance litigation by including “waiver of shariah defense” clauses in loan agreements and specific risk factors on shariah-compliance in capital market documents.
The current situation where shariah-compliance cannot be enforced in court can be seen to contradict the spirit of Islamic finance, which is based on an application of shariah rules to financial transactions.
New centers for dispute resolution have emerged that specialize in Islamic financing transactions. These bring together expertise in alternative dispute resolution and shariah law.
In arbitration, shariah law may be given preference over state law. This means that an arbitration tribunal can be a suitable forum in which to enforce the shariah promise.
This article deals with litigation-related aspects of Islamic financing transactions. It focuses on those enforcement and litigation issues that arise specifically from the shariah-compliant nature of a certain transaction—so-called shariah risk. It is based on an analysis of relevant court precedents, and provides concrete suggestions of what to bear in mind when drafting shariah-compliant agreements and capital market documents. It concludes with some reflections on whether it makes sense to set up specialized dispute review bodies for Islamic financing transactions.
When Things Go Wrong
Islamic finance litigation? Disputes arising out of shariah-compliant agreements were unheard of in the early days of Islamic finance. Banking transactions, by their very nature, are discrete, and as long as Islamic finance was confined to a small community there was no need to enforce contractual arrangements in court. The growth of Islamic finance, however, and the globalization of the Islamic finance industry, has transformed the industry from a community-based endeavor into a global business. In the global market, lenders default and banks sue and enforce. Islamic finance has become part of the global banking industry, and Islamic finance litigation is a side effect thereof.
Litigation based on or relating to Islamic financing transactions can raise intricate issues, in particular if debtors defend invoking shariah principles, in arguing that a contract or certain clauses are void as they do not comply with Islamic law (so-called shariah defenses). The spread and sophistication of the Islamic finance industry, as well as Islamic financial innovations, some of them based on controversial interpretations of the shariah, have further contributed to uncertainty in the Islamic finance community. Over the last decade, however, the courts have developed certain principles of how to deal with Islamic finance cases.
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