Arbitration in Islamic Banking & Finance Disputes
By Iskander Harhouz, student in the Economic Law master at SciencesPo,
The global head of International Swaps and Derivatives Association (“ISDA”) works on arbitration and ADR, Peter M. Werner, highlighted the benefits of arbitration and recognized a market increase in the use of arbitration in the financial sectors. Especially in relation to ISDA Master Agreements involving parties established or operating in emerging market jurisdictions.
Islamic Finance represents a growing number of financial transactions globally and can be valued in trillions of US Dollars. Islamic financial structures require high moral standards and the earnings of Islamic Banks come from identifiable assets. More precisely, Islamic Finance comprises all financial transactions that should comply with Shari’a. Thus, some things should be avoided, including gambling (qimar), uncertainty in a contract (gharar), unjust enrichment and exploitation, and the charging of interest (riba). As a result, some conventional finance practices, such as short-selling, are excluded in Islamic Finance.
This article will focus on some of the specificities of arbitration in Islamic Finance.
Theoretical background: Arbitration and Islam
Arbitration is a preferred method of dispute resolution in Muslim practice and is known as tahkim in Islamic Law. Quran mentions it:
“If you fear a breach between them twain (the man and his wife), appoint (two) arbitrators, one from his family and the other from hers: if they both wish for peace, Allah will cause their reconciliation. Indeed All is Ever All-Knower, Wall-Acquainted and with all things.’”
Arbitration was utilized not only in matrimonial but also in commercial disputes for many years. It became a popular method of dispute resolution in Islam because it brought the conflicting parties into negotiations (using principles of Shari’a).
Thus, commercial arbitration provides practitioners with a well-fitted forum for resolving disputes relating to Islamic financial instruments. Nevertheless, there are a few specific features to consider:
- Islamic Finance contracts deal with a very specific subject matter, thus there is a need for disputes relating to such contracts to be decided by experts in Islamic Finance;
- because of the contract’s subject matter, it is likely that the parties choose to have it governed, entirely or partially, by Shari’a; and
- the parties might also have some specific (Shari’a-based) procedural requirements.
There has been a debate however about the validity of the arbitration clause. The subject matter of an arbitration clause is a future issue, while the subject of contracts in Shari’a must be existent and legitimate to avoid Gharar. Some scholars also acknowledge that, “the arbitration clause participates positively in reducing the jurisdictional uncertainty” which enabled them to conclude that, “in view of this functionality [an arbitration clause’s] future effects should not be used as a reason for its invalidity”.
Advantage of Arbitration in Islamic Finance: the possibility to choose Shari’a as governing law
Litigation to resolve Islamic finance disputes has many drawbacks and one of the biggest is the non-application of Shari’a law by State Courts. The case of Beximco Pharmaceuticals v. Shamil Bank of Bahrain illustrates this drawback. Shamil Bank had entered into two murābaḥah agreements with Beximco, which contained a governing law clause that provided for two concurrent applicable laws, and which read as follows:
“Subject to the principles of the Glorious Shari’a, this Agreement shall be governed by and construed in accordance with the laws of England”
Mentioning “the existence of a variety of schools of thought with which the court may have to concern itself in any given case before reaching a conclusion upon the principle or rule in dispute”, the English Court of Appeal considered that the Shari’a law provisio was not enough to incorporate Shari’a principles into the agreements. As a result, it decided that the validity of the contract and the defendants’ obligations fell to be determined according to English law.
Commercial arbitration, on the other hand, is more favorable to the application of Shari’a principles. There is historically less reluctance to the application of non-State bodies of law in commercial arbitration.
The UNCITRAL Model Law on International Commercial Arbitration recognizes, at Article 28(1)(i), “rules of law” as a potential substantive applicable law, alongside “laws” and “legal systems”. While laws and legal systems refer to rules produced by States, “rules of law” is a broader notion that encompasses “anything that the parties perceive as their personal, communal or broader relationships, whether or not such “rules of law” are perceived by other persons or communities as binding, let alone as “laws”. By application of the UNCITRAL Model Law on International Commercial Arbitration, it is possible to choose Shari’a as governing law.
The English Arbitration Act of 1996 expressly enables the Tribunal to determine the case in accordance with the law chosen by the parties or “in accordance with such other considerations as are agreed by them [the parties] or determined by the tribunal”. As was confirmed by several decisions by English Courts, this provision means that arbitrators can rely on Shari’a to decide disputes brought before them.
A Shari’a compliant arbitral procedure – specific institutional arbitration rules
In addition to choosing Shari’a as the law (or as a concurrent law) governing their agreements, parties to Islamic Finance transactions might also have specific Shari’a-based procedural requirements.
Though some authors think there is no such thing as a specific Islamic arbitration procedure, it is also true to say that Shari’aprinciples might impose specific procedural requirements.
This would explain that several Islamic-law related/Shari’a-compliant arbitral institutions have emerged over time, such as the Asian International Arbitration Center (“AIAC”) or the International Islamic Center for Reconciliation and Arbitration. Concurrently, conventional secular arbitral institutions have adopted specific sets of rules for end-users seeking to resolve their disputes through procedures predicated on Shari’a.
One of the most significant features of Shari’a compliant procedural rules is their careful approach towards handling money and damages, to avoid riba based practices. In order to compensate a successful party for late payment of damages under an award, the AIAC designed a specific mechanism. The Arbitral Tribunal can grant it under article 13.5(o) of the AIAC-I arbitration rules 2021:
“In conducting the arbitral proceedings, the powers that may be exercised by the Arbitral Tribunal include but are not limited to: […] (o) unless otherwise agreed to by the Parties, award a late payment charge in accordance with the principles of Ta’widh and Gharamah …”
The AIAC considers that this mechanism recognizes the inability of the Tribunal to award interest on damages.
Another important service offered by Islamic arbitral centers is also the review of awards by experts to ensure that they are Shari’a-compliant which can be crucial to the parties in relation to the recognition and enforcement of awards because, in countries such as Malaysia and Saudi Arabia, courts scrutinize closely the conformity of foreign and domestic awards to the Shari’a.
A Shari’a compliant arbitral procedure – relevance of the choice of the seat of arbitration
When parties have particular Shari’a-based procedural requirements, it is also advisable that they choose a seat that satisfies such requirements. Departure from such procedural requirements will have consequences on the enforcement of the award.
Thus, although it is a Tribunal’s duty (amongst others) to issue an award that is consistent with the law of the seat, regardless of the requirements of the lex arbitri, parties should be careful when choosing the seat of their arbitration because it will have potentially undesired consequences on the enforcement of the award.
Under Article V(2) of the New York Convention on the recognition and enforcement of arbitral awards (“NYCA”), it is possible for the competent authority of the country where a request for enforcement of an arbitral award was made, to refuse enforcement of this arbitral award on the grounds that it is contrary to the country’s public policy. Thus, in countries where Shari’a principles irrigate national law, arbitral awards that are contrary to Islamic public policy will not be recognized nor enforced.
The risk of the award not being recognized is higher in some jurisdictions. As mentioned above, in countries such as Malaysia or Saudi Arabia, courts closely scrutinize the conformity of both foreign and domestic awards to the Shari’a.
It should be mentioned that it is possible to choose not only a country but also a special economic zone (“SEZ”) as the seat of arbitration, such as the Qatar Financial Center or the Dubai Financial International Center. Investors who chose to locate an activity in an SEZ benefit from special policies, measures, and a favorable sui generis legal framework as well as specialized courts. Seeing as SEZs are still embedded within the general legal framework of the country, this would subject arbitral proceedings to some desired procedural requirements, and awards issued in such seat will be susceptible to global enforcement (assuming the country is a party to the NYCA).
The possible trade-off between global enforcement and a Shari’a-compliant procedure
When considering certain jurisdictions as the seat of arbitration, there might also be a trade-off between the application of Shari’acompliant procedural rules and the possibilities of global enforcement.
This is the case for Islamic finance arbitrations seated in Malaysia. Specifically, it can be argued that arbitral awards rendered following a reference to the Shariah Advisory Council (“SAC”) lack enforceability under the NYCA.
Under Section 56(1) of the Central Bank Malaysia Act 2009:
Where any proceedings relating to Islamic financial business before any court or arbitrator any question arises concerning a Shariah matter, the court or the arbitrator, as the case may be, shall:
(a) take into consideration any published rulings of the Sharia Advisory Council; or
(b) refer such question to the Sharia Advisory Council for its ruling
Moreover, Section 57 of the CBAM provides that rulings made by the SAC are binding for the arbitral tribunals referring said questions to the SAC.
Considering that the ruling of the SAC is not optional but rather binding, scholars have concluded that an arbitral award rendered following a reference to the SAC would not be enforceable because it would infringe the NYCA. Article V(1)(d) of the NYCA provides that recognition and enforcement can be refused when a party brings proof that” the composition of the arbitral authority or the arbitral procedure was not in accordance with the agreement of the parties or, failing such agreement, was not in accordance with the law of the country where the arbitration took place”.
Such a conclusion is drawn from the fact that referral to the SAC constitutes a violation of the agreed composition of the Tribunal, a violation of the agreed arbitral procedure, as well as a delegation of powers and duties of the arbitral tribunal to the SAC members (all of this also amounts to a violation of party autonomy).
 J. Lawrence, P. Morton and H. Khan, “Dispute resolution in Islamic Finance”, Global Islamic Finance Report 2012.
 A. Connerty, “Methods of Dispute resolution for Islamic finance: Litigation and arbitration”, Transnational Dispute Management.
 S. Tsaturyan, “Litigation vs. arbitration & ADR for Islamic Finance Disputes – Theory & Practice”, Transnational Dispute Management.
 Quran, Surah 4 (Al Nisa Surah), Verse 35. Some people think that this verse refers to mediation rather than arbitration. Especially because of the number of people appointed, two, while in most arbitration laws, the arbitral tribunal must be composed of an odd number of arbitrators. Moreover, according to this verse, the third parties’ advice is not binding, and the husband and wife are free to follow or reject it. However, other verses in the Quran, such as Alnisa Surah, verse 65 or Almeiedah Surah, verse 95, as well as hadiths, point to the religious permissibility of arbitration. In the earliest days of Islam, the Prophet Muhammad (570-632) also encouraged and practiced arbitration to resolve a variety of disputes.
 J. Lawrence, P. Morton and H. Khan, op. cit.
 F. S. Al-Shibli, “Litigation or Arbitration for Resolving Islamic Banking Disputes”, Arab Law Quarterly 32 (2018) 413-438.
 A. Q. Farah, R. M. Hattab, “The Application of Shari’a Finance Rules in the International Commercial Arbitration”, Utrecht Law Review.
 F. S. Al-Shibli, op. cit.
 Beximco Pharmaceuticals Ltd & Ors v. Shamil Bank of Bahrain EC  EWCA Civ 19 (28 January 2004).
 UNCITRAL Model Law on International Commercial Arbitration, Article 28(1).
 I. Bantekas, “Transnational Islamic Finance Disputes: Towards a Convergence with the English Contract Law and International Arbitration”, Journal of International Dispute Settlement.
 English Arbitration Act 1996, s46(1)(b).
 Musawi v. R E International (UK) Ltd & Others  EWHC 2981 ; The Investment Dar Co KSSC v. Blom Development Bank S.A.L.
 Ilias Bantekas, “The Qatar Financial Center Court and How it can Attract Islamic Finance Arbitration”, Transnational Dispute Management: “the arbitral procedure, as such, is immaterial to any of the elements of Islamic finance. In fact, international commercial arbitration is so entrenched in party autonomy and flexibility that the parties are in no way hindered in their choice of arbitrators, rules of procedure, language, or other mutually agreed features”.
 AIAC-i Arbitration Rules 2021, Part I, Article 13.5.
 AIAC-I Arbitration Rules 2017, Part IV (FAQ), Question n°18.
 Ilias Bantekas, “Transnational Islamic Finance Disputes: Towards a Convergence with the English Contract Law and International Arbitration », Journal of International Dispute Settlement.
 A. Q. Farah and R. M. Hattab, op. cit.
 Ilias Bantekas, “Transnational Islamic Finance Disputes: Towards a Convergence with the English Contract Law and International Arbitration”, Journal of International Dispute Settlement.
 A. Tugushev, “Protection of Investment and Violations of Investor’s Rights in Special Economic Zones”, Transnational Dispute Management.
 I. Bantekas, “The Qatar Financial Center Court and How it can Attract Islamic Finance Arbitration”, Transnational Dispute Management.
 A. Abdul Rahman, “Islamic finance arbitration: enforceability under the New York Convention 1958 of arbitration awards made following a reference to the Shariah Advisory Council under the Central Bank of Malaysia Act 2009”, Kluwer Arbitration.
 Convention on the recognition and enforcement of foreign arbitral awards (https://www.newyorkconvention.org/11165/web/files/original/1/5/15432.pdf).
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