Arbitration in Islamic Finance: A Favorable Alternative or a Fashionable Trend?

By Pooja Unnikrishnan, Student at Alliance School of Law, Alliance University, Bengaluru

An Overview of Islamic Finance 

In recent years, financial activities conducted under the banner of “Islamic finance” have grown significantly in volume and scope, attracting significant attention worldwide. The Islamic finance industry came about in the 1970’s and since then, it has steadily expanded with the demand for Sharia laws compliant products and services. The industry’s total assets have reached US $ 2.5 trillion globally in 2019.

Singapore has pioneered in the adoption of Islamic banking followed by Hong Kong, Luxembourg, the United States, and other countries with large Muslim communities. 

Islamic financing is a type of financial activity that rigidly follows Sharia laws. Islamic banking is advantageous as compared to conventional banking as it is based on a well-established ethical code and moral principles. One substantial difference between Islamic banking and conventional banking is that the former does not deal with interest, whilst interest, is an important component of transaction in the latter. Another notable advantage of Islamic banking is that customers receive profits based on identifiable assets since Islamic banking does not deal in derivatives or other securities. By doing so, any aspect of uncertainty or speculation is completely ruled out and financial dealings are in tune with the Sharia laws. Furthermore, Islamic finance has also accelerated social finance which is in line with UN’s Sustainable Development Goals. The concept of Zakat funds and Sukuk bonds prove to be significant during the times of crisis.

Therefore, this article gives an overview of the key elements of Islamic finance and gives a broad perspective on its macroeconomic implications from its expansion across the globe. 

Litigation Issues in Islamic Finance Disputes

Islamic finance litigation in practice adjudicates Sharia disputes within the civil judicial framework. Sufficient knowledge of Sharia laws and civil laws is essential to resolve such disputes. 

When parties opt for litigation to resolve Islamic finance disputes, the laws of other jurisdictions wherein the Rome Convention applies, may be inconsistent with the Sharia laws. As observed in the case of Shamil Bank of Bahrain v. Beximco Pharmaceuticals, the English Court of Appeal established that there was only a general reference of the Sharia law made in the agreement, which was devoid of specific Sharia principles and hence, the court ruled in favour of the application of the English law. In another instance, in Kevin Murray v. United States Department of Treasury, there was a long-drawn battle between the U.S taxpayers and the U.S. federal government when U.S funds were used to support AIG’s Sharia businesses. Applying the Lemon Test to assess whether there was undue mix-up between religion and state related to Islamic financial instruments, the Court concluded that the Islamic financial instruments comprised only a small percentage of the complete business portfolio, and that the primary effect of utilizing the Islamic financial instruments did not support or hinder any religion. In another case, namely, Halpern v. Halpern, the Court of Appeal (England and Wales) observed that there was a common issue of enforcement of Sharia laws since detailed contractual provisions is a requirement. 

With the emergence of the global economy market, several jurisdictions have come to be more or less neutral in terms of resolving disputes. The problem, however, lies in the lack of expertise and knowledge of the courts to understand and acknowledge various facets of Islamic finance which can help mitigate risks associated with the application of Sharia laws.

Benefits of Arbitration in Islamic Finance Disputes 

Arbitration can be a useful option to resolve Islamic finance disputes since arbitral tribunals are neutral fora and parties have the choice inter alia to select their arbitrators, procedure of arbitration. Most importantly, confidentiality is an essential canon of arbitration, and hence, it advocates Sharia laws. 

There is a legal indication for affirming the option to arbitrate Islamic finance disputes. For instance, Article 35(1) of the DIFC Arbitration Law emphasizes that a tribunal can arbitrate disputes “in accordance with such rules of law as are chosen by the parties as applicable to the substance of the dispute”, here, the substance of the dispute can be Sharia laws as per the choice of the parties to the dispute. 

Further, in Sanghi Polyesters Ltd. (India) v. The International Investor KCFC (Kuwait), English court has confirmed the enforcement of a Sharia award and it is understood that English law or any preferable choice of law of the parties can be applied subject to the exceptions and limitations posed by the Sharia laws. 

It is pertinent to observe that many jurisdictions are in the process of adopting and already have adopted rules for arbitration specifically in the Islamic banking and finance sector. For instance, the KLRCA Rules 2012 referred to as the i-Arbitration Rules encourages the resolution of disputes arising from any contract that contains Sharia law issues. The International Islamic Centre for Reconciliation and Arbitration (IICRA) established in Dubai is another valuable attempt to boost settlement of all kinds of banking, financial and commercial investment, and real estate disputes with compliance of Sharia Law through the institutional Reconciliation and Arbitration.

Conclusion

From the aforesaid facts and observations, it is safe to say that parties to Islamic finance disputes are taking recourse to arbitration. This is mainly because of the development of institutions as well as rules specifically in the Islamic finance arbitration sector which provides parties with an option to resolve such disputes in a neutral manner. The penumbra, however, lies in the fact that strict compliance of Sharia laws is a caveat to resolve any Islamic finance dispute. 

Therefore, there is a need for more experts in the field to resolve Islamic disputes as following a secular or partially secular arbitration may defeat the principles of Sharia laws. Arbitration clauses in Islamic agreements need to be drafted meticulously to avoid vagueness. This would also enable careful application of Islamic arbitration rules for resolution of Islamic disputes. A notable development in this regard is the optional provision under the ISDA/IIFM Ta’hawwut Master Agreement which encourages Sharia compliant transactions at a cross-border level. 

Hence, arbitration in Islamic finance has proved to be a workable alternative to conventional litigation because of parties’ preference and exponential developments in the commercial arbitration sector. Besides, arbitration tenets like party autonomy, flexibility, confidentiality and efficiency make it an appealing option to contracting parties to resolve their Islamic finance disputes.