Monday, March 01, 2010

Can a debtor avoid obligations by claiming a contract is not Shari'ah-compliant

King & Spalding has a very interesting short article (pdf) about a case in English courts where a creditor of the Investment Dar sued TID to try and recover principal plus expected profit from a wakala agreement they entered into. TID responded that:
(i) TID was prohibited by its constitutional documents from entering into agreements which did not comply with shari’ah, (ii) the Agreement did not comply with shari’ah and (iii) the Agreement had been entered into beyond the corporate powers of TID and was therefore void.
King & Spalding suggest that this raises the prospect for Shari'ah risk across the industry.

The risk lies in Islamic financial institutions trying to avoid repayment on contracts they entered into by arguing that the contracts could not have been validly entered into because they were not Shari'ah-compliant and therefore the company could not have legally entered into them (because the corporate requirements were that all transactions must be Shari'ah-compliant). However, in this case, TID entered into the contract and later argued that it had not been Shari'ah-compliant. In my (non-lawyer) eyes, this essentially provides non-Shari'ah-compliance as nearly a blanket way to get out of contracts in the future if the IFI is in financial distress. The cause for the rationale by TID in this case may have been to avoid a disruption to its restructuring agreement if creditors could exit the restructuring and seek redress through English courts which govern most Islamic finance contracts.

I think the King & Spalding suggestions that close the article could provide a way to prevent this from occurring with regularity in the future and mitigate the Shari'ah risk from IFIs claiming after the fact that some contracts they entered into were not Shari'ah-compliant and were therefore void.
(i) That the IFI delivers a certificate of its shari’ah committee, or internal shari’ah advisor, confirming that the transaction is shari’ah compliant.
(ii) The deletion of any prohibition in the constitutional documents of the IFI which prohibits that IFI from entering into agreements which do not comply with shari’ah.
(iii) A representation to be inserted into the shari’ah compliant agreement stating that entry into and performance by the IFI of that agreement does not conflict with any of its constitutional documents.
(iv) The waiver by the IFI of any defenses that it might have in connection with the agreement not
being compliant with shari’ah principles.
I would suggest reading the full article because it contains more insights that I may have overlooked.

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