<p>As the Islamic financial market becomes increasingly global, financial  participants from multiple jurisdictions are taking opportunities to gather  their resources and form alliances to jointly participate in the global  business. As a consequence, and given that the cornerstone of Islamic finance  transactions are the application of Shariah principles, such principles are  being adapted into international commercial agreements and assimilated into a  non-Islamic legal environment. Attempts are being made to implement Islamic  finance transactions in jurisdictions which are not bound to give effect to  Islamic principles, at least where commercial agreements are  concerned.<br /><br />Most countries have adopted either the common law, or civil  law system, and there is a lack of a comprehensive legal system to support the  application of Islamic principles in Islamic finance transaction documents. Even  if market participants agree to use contracts based on Shariah principles, most  laws and the courts lack the sufficient and specific legal backdrop,  infrastructure, resources and expertise to interpret and enforce the transaction  documents Islamically.<br /><br />In certain countries like Pakistan, Egypt and  Malaysia, despite the existence of Shariah judicial systems, the application of  Islamic laws are limited to traditional areas of law such as family laws,  marriage and inheritance. Even where some countries have successfully  established separate Islamic statutes such as Islamic banking laws passed by  Kuwait and Malaysia, its applications in the respective judicial systems are  limited and are still the subject of debate.<br /><br />The issues which arise as a  result of the increasing participation of financial institutions and other  market players from multiple jurisdictions in a single Islamic finance  transaction in light of the above mentioned scenario are mainly two-fold &mdash;  firstly, the choice of governing law which will govern the Islamic finance  transaction documents and extent to which Islamic law principles are applied  within the chosen governing law framework, and; secondly, given the lack of an  Islamic legal system, the proper forum of dispute resolution for disputes under  the Islamic finance transaction documents. This article attempts to outline the  challenges surrounding both issues.<br /><br /><strong>Role of Shariah principles  vis-&agrave;-vis the choice of governing law </strong><br /><br />All finance transaction  documents have a governing law clause. Although rarely the primary concern of  the parties, the choice of governing law can be a point of confusion for  cross-border finance transactions involving parties from multiple jurisdictions.  For a conventional cross-border finance transaction, although still an important  point, there is less complication as there is no requirement to consider the  application of Islamic principles. Rather the issues revolve around the  applicability of the choice of law in the jurisdiction where a party  contemplates a legal action in other jurisdiction and the enforcement of a  foreign judgment in the jurisdiction where the obligor resides and/ or where the  assets of the obligor are located.<br /><br />With Islamic finance transactions, the  choice of law is more delicate given that the parties will naturally want to opt  for Islamic law as the governing law of the finance documents. As Shariah is not  a national system of law and there is no one standard codified Islamic law to be  used as guidance and reference, parties cannot merely adopt Islamic law as the  governing law without reference to the law of a particular jurisdiction.  Therefore, a national law system is often used as the governing law to provide  more certainty on the rights and obligations of the transacting  parties.<br /><br />The reference to Shariah principles is embedded in the provision  on the governing law, often drafted in such a way that the governing law will be  used subject to the Shariah principles. Such provision gives rise to the  question as to the extent of applicability of Shariah principles in the law of a  chosen jurisdiction. In practice, English law is widely chosen as the governing  law of Islamic cross- border finance transactions.<br /><br />There is ample  evidence to suggest that the reference to Shariah rules and principles amid the  choice of law clauses such as illustrated above are included in the Islamic  finance transaction documents with no particular thought of the effect or  implementation of the provision by the judicial system. Therefore, it is not  surprising for the parties to provide for the Shariah principles the law of a  specific domestic jurisdiction, only to discover later in litigation that the  courts lack the expertise or resources to implement the Shariah  rules.<br /><br />There have been a number of cases litigated in the English courts  involving Islamic finance agreements, where the courts examined the issue of the  governing law in such agreements.<br /><br />One of such case, Shamil Bank of  Bahrain v Beximco Pharmaceuticals, illustrates this point very well. The case  was significant because for the first time, the questions of the validity,  interpretation and scope of the English law vis-&agrave;-vis Islamic principles were  considered by a secular court.<br /><br />In that case, Shamil Bank of Bahrain  (Shamil Bank) claimed that certain monies were outstanding from Beximco  Pharmaceuticals (Beximco) under a Murabahah agreement. The governing clause in  the Murabahah agreement stated that &ldquo;subject to the principles of the glorious  Shariah&rdquo;, the agreement would be governed by and construed in accordance with  the laws of England. Beximco argued that the agreement was contrary to Shariah  law and therefore was not enforceable.<br /><br />The judge in the first instance  held that English law was the governing law and there was no scope for the  Shariah law to apply as there could not be two separate law systems governing a  transaction. Further, it would be highly impossible that an English secular  court would apply religious principles in making the determination of a dispute.  The appeal by Beximco against the decision of the first instance judge was  dismissed along the same arguments. The judge in the English Court of Appeal  case further argued that the general reference of the Shariah law in the  agreement did not identify any specific Shariah principles to be applied and  further ruled that the reference to Shariah law is repugnant to English  law.<br /><br />The above case illustrates two main challenges, first, the  reluctance of a secular court to admit the application of Shariah principles and  second, the scope for potential abuse by defaulting obligors to use Shariah  invalidity arguments to avoid making payments under the Islamic documents. Due  to the various interpretations of Islamic finance structures, defaulting  borrowers have the opportunity to &lsquo;shop around&rsquo; for the Shariah view which  favors their argument of Shariah invalidity which will absolve them from the  responsibility of payment of amount owing, which is why in the above case, the  judge determined that the sole intention of Beximco was to obtain financing from  Shamil Bank. Therefore the form of the agreements and the impact of the Shariah  law on the validity of the agreement were not points of contention.<br /><br />The  judgment of the Court of Appeal relating to 11 separate cases involving Bank  Islam Malaysia and Arab Malaysian Finance confirmed the validity of certain  Islamic finance structure in Malaysia. Similarly, the Michigan district court  has recently dismissed a case alleging that AIG&rsquo;s Shariah compliant financial  services violated the constitution of the US; however the interpretations of the  Islamic principles are still being debated. In the Malaysian case, the judge  stated that the notion that the question of whether an Islamic finance  transaction is Shariah compliant is finally determined by the Shariah board is  flawed. While the courts will take into account the views and opinions of the  Shariah scholars, the final decision maker on making a determination of such  issue will be the court. Arguably, these two cases opened up the acceptability  and recognition of Islamic principles in the secular judicial systems although  its application is still vague and unclear.<br /><br /><strong>Choice of dispute  resolution<br /></strong><br />There is also the question to the choice of forum. If  there is a legal dispute, where will the dispute be resolved? As discussed in  the preceding section, there is an absence of judicial systems capable of  litigating and enforcing Islamic finance documents. Secular courts do not have  the capability to ascertain and determine what does or does not comply with  Shariah. Even among Shariah experts there can differences in matters of  interpretation of Islamic law.<br /><br />In light of the above, the question is  whether a dispute resolution through arbitration over the judicial courts is  able to resolve the issue of application of Shariah principles in Islamic  finance documents.<br /><br />Arbitration is recognized under the Shariah. The  advantages of arbitration are that the parties can participate in the process;  work and decide on the outcome together, as opposed to against each other. This  can help maintain, restore or rebuild their relationship and save costs and  time. The alternative dispute resolution approach is generally more efficient,  private and more flexible for both parties as compared to litigation. The  parties are able to emphasize that the aim of the arbitration is to have  disputes resolved in accordance with Shariah principles.<br /><br />Arbitration  provides an avenue to bring in and appoint Shariah scholars as arbitrators,  which could issue an arbitration award which is a binding decision on the  parties. However, the arbitrators or other persons involved in arbitration  procedures also need to have some familiarity with financial, commercial and  legal issues and not just the Shariah issues. The arbitration award, however,  still requires enforcement in the secular courts. This requires the  determination as to whether the arbitration award is enforceable in the relevant  jurisdiction.<br /><br /><strong>Conclusion</strong><br />For a conventional  cross-border finance transaction, the choice of governing law and dispute  settlement resolution constitutes important sections of the document. The  parties have to consider the legal consequences stemming from choosing a law of  a particular jurisdiction, such as the issue of the applicability of such  governing laws in the jurisdiction where a party chooses to bring a legal  action, conflicts of&nbsp; law rules and enforcement of foreign judgments in a local  jurisdiction.<br /><br />When the parties use Islamic finance structure, another  layer of governing law or principle is referenced to the finance document which  adds to the complexity of the existing issues. It seems to be easy enough for  the parties to merely include in the finance documents a clause that the  governing law is subject to Shariah principles without giving much thought to  the legal consequences. In a legal environment where there is an absence of a  judicial system that can uphold and implement Islamic principles in Islamic  finance documents, a governing law clause with a reference to Shariah principles  seem to be irrelevant and has no particular effect.<br /><br />The best practice  which has been increasingly adopted by legal practitioners in Islamic cross  border finance documents is to include a representation that the parties are  satisfied that the agreement complies with the Shariah and a provision whereby  the parties agree not to seek to challenge the enforceability of the agreement  in the future on the basis of non-compliance with Shariah  principles.<br /><br />Consequently, the governing law clause only provides for the  choice of law and without reference to Shariah. In addition, parties involved in  Islamic cross border finance transactions have increasingly opted for  arbitration as the choice of dispute resolution to take advantage of the  flexibilities it offers and the opportunity to bring in Shariah and financial  experts as arbitrators. For example in Kuwait, the court is more willing to  enforce a foreign arbitration award.&nbsp;<br /><br /><em>This article was originally  published in Islamic Financial News on; May 25, 2011 volume 8, issue 20.</em></p>