Undertaking financial activity in accordance with Islamic precepts is a growing area of international business for many banks. Critical to any banking product is the enforceability of the contracts. An Islamic banking product not only has to reflect Sharia principles but also be enforceable under the prevailing law. There has been virtually no judicial guidance on this concern within the scope of Islamic financing. The January 2004 refusal by the House of Lords to allow a petition to appeal the Court of Appeal decision in Shamil Bank of Bahrain EC v Beximco Pharmaceuticals & ors brings some certainty.

The case concerned Islamic financial transactions entered into in the mid-1990s between the bank and corporate customers. The debtors defaulted and after a lengthy period the deals were restructured so the bank’s religious supervisory board was satisfied with Sharia compliance.

After several more years of non-payment, the bank gave notice of default and went to the English High Court. The case centred on a governing law clause in the agreements: “Subject to the principles of the Glorious Shari’ah, this Agreement shall be governed by and construed in accordance with the laws of England.” This formulation has been in use for several years in Islamic financial documents. The defendants argued that the financial arrangements were not enforceable under Sharia principles as they were merely a disguised interest-bearing loan (interest is prohibited under ‘Riba’). Awarding summary judgment in favour of the bank, the High Court found that it was “improbable in the extreme” that the parties would have intended that the High Court make decisions on “matters of Islamic religion and orthodoxy”, and that Islamic financial institutions could ensure compliance with Sharia by submitting themselves to “the supervision and scrutiny of the religious supervisory boards”.

The Court of Appeal dismissed the appeal by explaining that the reference to Sharia was to reflect the Islamic principles, by reference to which the bank held itself out as conducting business, while English law would be applied in ascertaining the liability of the parties under the terms of the agreement. The Court of Appeal applied Articles 1(1), 3.1 and 3.3 of the Rome Convention in determining that the choice of law had to be one that related to the laws of a defined nation. The reference to ‘Glorious Shari’ah’ was neither a reference to a national legal system nor to a defined set of rules, the High Court having previously found that there is “clearly great controversy as to the strictness with which principles of Shari’ah law will be interpreted or applied”, even between Muslim countries such as Pakistan or Bahrain.

Now that the Lords have refused to hear a further appeal, the High Court decision, buttressed by the Court of Appeal, sets down the UK legal position regarding the judicial interpretation of Islamic financial transactions expressed to be governed by English law. It has increasingly become ‘best practice’ among bankers and their legal advisers to adopt English law. These judgments strengthen that choice, provided those offering Islamic products ensure that each product has been approved by their religious supervisory board. Sharia compliance has always been a subjective matter for the individual. As a corollary, it is now clear that a bank can determine the Sharia compatibility of the products it feels comfortable offering by obtaining an opinion from its religious supervisory board. If a customer wishes to purchase an Islamic product, they should ensure that they are happy that it is Sharia-compliant. Having signed the contract, they cannot then try to avoid liability by denying its Sharia credentials. The English courts have demonstrated a willingness to prevent what would otherwise become a fraudster’s charter and, in so doing, have created a firm foundation for the continuing development of Islamic financial techniques.

Neil Miller, partner and global head of Islamic finance, Norton Rose