Thursday, December 26, 2013

Shariah and BLOM Bank

In the case of Investment Dar Co KSCC v Blom Developments Bank Sal, the Investment Dar (TID) was an investment company registered in Kuwait and the Blom Development Bank (BDB) was a bank incorporated in Lebanon. A wakalah investment agreement was entered into between the two parties governed by English law. The agreement provided that Blom deposit a certain amount of money with TID, appointing TID as its wakil (agent) to manage the money as an investment. When TID defaulted on payments under the wakalah agreement, BDB sued TID in the High Court of England and applied for summary judgment on the grounds of default in payment (claim in contract) and the deposits held in trust (claim in equity). The master found that there was an arguable defence to the contractual claim, but not to the trust claim due to a misunderstanding of Shariah and the application of common law to an Islamic finance transaction.

TID raised the defence of ultra vires. TID argued that the wakalah agreement, which was approved by its own Shariah board, did not comply with the Shariah and was therefore void and against TID's constitutional documents. Although within the wakalah arrangement some issues of Shariah non-compliancy arose, since the contract was approved by the TID Shariah Board and constituted a binding contract in both common and Islamic law with valid offer and acceptance. Thus, TID should have been held to the terms of the contract.

In terms of Islamic law, the Hanafis stipulated a valid offer and acceptance as the cornerstones of the agency contract. While the Hanafis restricted the contracts cornerstones to offer and acceptance or actions implying acceptance, the other jurists enumerated four cornerstones: (i) principal, (ii) agent, (iii) object of the agency contract, and (iv) the contract language. If the compensation is a ji'alah, whereby the task and the time period are not explicitly stated in the contract, then the majority of jurists agree that the contract is non-binding on the parties.

However, the Malikis ruled that the contract was, in this case, binding on the principal once the agent begins working. If the compensation renders the contract an ijarah, then the Hanafis and most Malikis ruled that the agency contract is thus binding. In contrast, the Shafis and Hanbalis ruled that the contract was still not binding in this case. In this instance, according to the Hanafis, the contract had valid offer and acceptance with principal and an agent consenting to the terms of the contract and initiating investment activity in the form of a wakalah. In addition, the wakalah contract appears to be an ijarah and thus valid and binding according to the Hanafis and Malikis.

According to the AAOIFI Shariah standard No. 23 (4/3) and as occurred in this case, "when agency is paid, involves the rights of others, when the agent commences tasks that cannot be discontinued or phased out without causing injury to him or to the principal, and/or when the principal or the agent undertakes not to revoke the contract within a certain period, it falls under the Shariah rulings on Ijarah and is binding." The judge ignored the valid and binding contract and the original contractual intent of the parties, applied western trust law to the wakalah arrangement, and unjustly ruled that TID was only liable to pay Blom the principle amount.

In the concerned wakalah arrangement, at the end of every wakalah period, TID was obligated to pay five percent profit to Blom . The issue arose when TID defaulted on payments of Blom 's principal and the agreed profits. Blom claimed that TID should pay it the principal deposits plus the contractually agreed five percent profit. However, TID argued that the agreement was not Shariah-compliant, being an agreement for deposit taking with interest, and therefore null, being ultra vires and beyond its legal capacity to conform. The Judge concurred and stated, "I agree...that where one finds, as one does in this master wakalah contract, a device to enable...the payment of interest under another guise, that is at least an indirect practice of a non-Shariah compliant activity." Due to constraints faced by the Islamic banking industry in terms of risk management, the reality of operating in a conventional system, and the need to compete, it is difficult to adhere to true Shariah banking at this moment in time[SO1] . It may be argued that in fact all Islamic banking products are devices to enable the payment of interest in another guise.

According to the AAOIFI Shariah Standard No. 5(2/2/2) on Guarantees, "it is not permissible to combine agency and personal guarantees in one contract at the same time, because such a combination conflicts with the nature of these contracts. In addition, a guarantee given by a party acting as an agent in respect of an investment, turns the transaction into an interest-based loan since the capital of the investment is guaranteed in addition to the proceeds of the investment (i.e. as though the investment agent had taken a loan and repaid it with an additional sum, which is tantamount to riba)." In this case, TID, as agent, also guaranteed Blom a five percent return. However, even if the wakalah agreement in question really was a loan with interest in disguise or a similar contraption, due to the fact that this agreement was approved by the TID Shariah board, TID should be held to the terms of the contract. TID should not be allowed to suddenly claim that the transaction is non-Shariah compliant in order to evade its contractual obligations to Blom Bank.

According to records, Jurists agree that an agent's possession is one of trust, analogous to deposits and similar to possessions. This ruling follows from the fact that the agent would possess goods as a legal representative of the principal (who is the owner). Thus, his possession is similar (but not the same) to that of a depository, following its rules for trust and guarantee. Under Shariah, TID was holding the five percent profit on trust for Blom as agent for principal even if the guarantee combined with agency is thought by some to have turned the wakalah into a deposit taking with interest or to have simulated an interest-bearing loan.

Although under Shariah, TID was technically only supposed to receive an agency fee, in this wakalaharrangement, TID was contractually to receive an agency fee plus all return above five percent, thus bearing risk of loss. In a proper wakalah arrangement, the principal bears all risk of loss and profit, while the agent only receives an agency fee. According to the AAOIFI Shariah Standard No. 21(4/2/c), "the amount payable as remuneration for agency should be known, whether in lump sum or as a share of a specific amount of income. It may also be defined in terms of an amount of income to be known in the future, as when remuneration is linked to an indicator that may be quoted at the beginnings of different intervals of time. However, it is not permissible to leave remuneration for agency undetermined and allow the agent to take an unspecified share from the entitlements of principal." In this arrangement, the agent was to take an unspecified share from the entitlements of the principal, being any amount of return above five percent. These Shariah issues were totally ignored by the judge. In this transaction, the judge misapplied Shariah law, ignored the reality of the Islamic finance and banking industry, and then judged the contracts in relation to Western trust law, unfairly ruling that Blom was only entitled to the principal amount.

The judge ordered an interim payment to be paid to Blom based on the fact that the contract was null and void (no trust) and that the transaction was ultra vires (non-Shariah compliant). The judge should have ruled thatBlom was entitled to the deposit amount plus any profit made up to a limit of five percent (if profit was made) rather than just the deposit amount. TID ultimately withdrew the case.

About: Camille Paldi is associate with Alhuda-CIBE, She is a legal expert and founder of FAAIF Limited as well as the popular In addition to being a qualified Islamic finance specialist with a Masters Degree in Islamic finance from Durham University (UK), Camille is also a lawyer in four countries and nine jurisdictions around the world and has received legal training in common, civil, and Shariah law in six countries spanning five continents.

Source: Zawya

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