Shariah as the governing law of Islamic finance contracts in the UK: The impact of Rome I Regulation and the position in arbitration

by Abdullah Abdul Rahman (Partner (Dispute Resolution and Islamic Finance) of Cheang & Ariff in Kuala Lumpur)

 

In Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others [2004] 4 All ER 1072, the English Court of Appeal did not accept Shariah as the governing law of a contract. This was notwithstanding that the contracts in question were Islamic banking contracts based on the Murabahah and Ijarah principles. The Court of Appeal made that decision on the basis of the Rome Convention on the Law Applicable to Contractual Obligations 1980 (‘Rome Convention’) which had the force of law in the United Kingdom.

However, the position in Beximco is no longer applicable after the Rome Convention was replaced by the Regulation (EC) No. 593/2008 of the European Parliament and of the Council on the Law Applicable to Contractual Obligations, known as the Rome I Regulation (‘Rome I Regulation’) and the coming into force of that regulation in the UK on 17 December 2009. The Rome I Regulation permits the Shariah as the governing law of a contract.

In any event, the position in Beximco had been confined to litigation. It has never been applicable to arbitration. This is due to s. 46(1)(b) of the English Arbitration Act 1996 which permits the application of the Shariah as the governing law of a dispute in an arbitration. This position on arbitration has been confirmed by the decision in Musawi v R.E. International [2008] 1 All ER (Comm) 607.

 

Beximco and the Rome Convention

In Beximco, the defendant was the plaintiff’s customer, who was an Islamic bank incorporated in Bahrain. The defendant defaulted on the repayment of the Murabahah and Ijarah based banking facilities granted to them and the bank sued in the English court. The governing law clause provided as follows: “Subject to the principles of the Glorious Sharia’a, this Agreement shall be governed by and construed in accordance with the laws of England.” The defence was that the agreements had to comply with both English law as well as the Shariah; and since the Murabahah and Ijarah based agreements were not in compliance with the Shariah, they were not enforceable.

It was common ground between counsel that there could not be two governing laws in respect of the agreements. This point of law was accepted by the court. As between the English law and the Shariah, the court applied article 3(1) of the Rome Convention which provided ‘A contract shall be governed by the law chosen by the parties’ (emphasis by the court). The court then came to the conclusion that the phrase ‘the law’ permitted the choice of only the law of a country and not a non-national system of law such as the lex mercatoria, general principles of law, or the Shariah. This is because the court found that there were clear indications that the Rome Convention as a whole contemplated and authorised only the choice of the law of a country. This was based on article 1(1) of the Rome Convention which provided ‘The rules of this convention shall apply to contractual obligations in any situation involving the a choice of laws of different countries’ as well as the reference to a choice of ‘foreign law’ in article 3(3). Therefore, ‘the law’ in article 3(1) of the Rome Convention did not permit the choice of non-national law such as the Shariah. As such, the court rejected the Shariah as the governing law of the contracts and applied the English law only.

 

Rome I Regulation

The Rome Convention was replaced by the Rome I Regulation and the latter came into force in England by virtue of The Law Applicable to Contractual Obligations (England and Wales and Northern Ireland) Regulations 2009. Article 3(1) of the Rome I Regulation reads ‘A contract shall be governed by the law chosen by the parties’ thus, maintaining the wording of the corresponding article in the Rome Convention.

However, it made significant changes elsewhere which permit the application of non-national law as the governing law of a contract. Article 1(1) of the Rome I Regulation leaves out the phrase ‘a choice between the laws of different countries’ found in article 1(1) of the Rome Convention which had been the crucial basis of the decision in Beximco. Article 1(1) of the Rome I Regulation reads: “This Regulation shall apply, in situations involving a conflict of laws, to contractual obligations in civil and commercial matters.” The change in the wording of article 1(1) reflects the desire to permit the application of non-national laws in contracts.

Any doubt as to whether the phrase ‘conflict of laws’ in Article 1(1) of the Rome I Regulation includes a conflict involving a non-national law is removed by Preamble 13 to the Rome I Regulation. Preamble 13 reads “This Regulation does not preclude parties from incorporating by reference into their contract a non-State body of law or an international convention.” Thus, it is clear that the Rome I Regulation permits the parties to apply non-national law as the law governing their contracts. This, in turn, should permit the application of the Shariah as the governing law of contracts enforceable by the English courts.

 

The governing law where the parties refer to arbitration

Where a dispute is referred to an arbitration governed by the English Arbitration Act 1996, s. 46(1) of the said Act provides “The arbitral tribunal shall decide the dispute – (a) in accordance with the law chosen by the parties as applicable to the substance of the dispute or; (b) if the parties so agree, in accordance with such other considerations as agreed by them or determined by the tribunal.” Thus, in Musawi v RE International, the English High Court held that under s. 46(1)(a) the applicable law must be the law of a country. Then, on s. 46(1)(b) the High Court relied on Dicey, Morris and Collins on the Conflict of Laws (14th ed.) which states that the provision “allows the parties the freedom to apply a set of rules or principles which do not in themselves constitute a legal system. Such a choice may thus include a non-national set of legal principles (such as the 1994 UNIDROIT Principles of International Commercial Contracts) or, more broadly, general principles of commercial law or the lex mercatoria.”

Consequently, prior to the coming into force of the Rome I Regulation, where parties have agreed to apply a non-national law as the governing law of their contract, the applicability of the non-national law as the governing law depended on whether the dispute was resolved in court or by arbitration. If the dispute was referred to court for resolution, then the non-national law did not apply. However, the position was different where the parties referred their dispute to arbitration. In such a situation, the arbitral tribunal shall decide the dispute in accordance with the non-national law agreed by the parties.

The non-national law includes Shariah. This was the case in Musawi v RE International. In that case, the parties agreed to refer their dispute to an arbitration by an Ayatollah in accordance with the Shia Shariah law. The High Court held that this was an agreement that the parties were entitled to make under s. 46(1)(b) of the Arbitration Act 1996. The position that the phrase ‘such other considerations’ in s. 46(1)(b) applies to religious laws in an arbitration has been confirmed by the Court of Appeal in Halpern v Halpern [2007] 2 All ER (Comm) 330, which is a case concerning the application of the Jewish law to a contract.

Finally, parties hoping for their arbitration to be governed by the Arbitration Act 1996 must be aware that the Act will apply only if the seat of arbitration is in England and Wales or Northern Ireland. The seat may be expressly provided for in the arbitration agreement. The seat may also be indicated by the arbitration agreement providing that the arbitration will be anywhere in England and Wales or Northern Ireland. Failure to expressly provide for or indicate the seat may result in a decision that the seat is not in England and Wales or Northern Ireland and therefore the Act does not apply.

 

Conclusion

With the Rome I Regulation superseding the Rome Convention, the courts should no longer reject the Shariah as the governing law agreed by the parties in their Islamic finance contracts.

However, perhaps it is better for parties to refer their disputes to arbitration as there is a greater certainty that the Shariah will be applicable as the governing law for Islamic finance contracts where parties have agreed as such. The parties would also be able to appoint arbitrators who are experts in Shariah to decide on the dispute as conducted in Musawi v RE International. With this, there will be greater assurance that the decision on the dispute will be in compliance with the Shariah and in accordance with their intention as indicated by the choice for Islamic finance.

 

Abdullah Abdul Rahman is a Partner (Dispute Resolution and Islamic Finance) of Cheang & Ariff in Kuala Lumpur. He could be contacted at abdullah@cheangariff.com.

This posting first appeared as an article on 13 August 2014 in the Islamic Finance News (IFN) magazine published by REDmoney.

 

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