NEWHORIZON

NEWHORIZON April to June 2013
FOOD FOR THOUGHT
have struggled to reconcile
between the substance and form
of contracts used by IFIs. Was
it a true sale, lease, construction
or partnership contract or a
financing arrangement between
the parties? Even when an Islamic
contract, such as murabaha, results
in a debt, it leads to discord and
disagreements as to the exact
amount of debt owed by the
customer to the Islamic bank.
In numerous BBA cases
in Malaysian courts, the
determination of the amount
due to an IFI in a 20 or 25 year
murabaha financing contract,
which ended earlier as a result of
the default of the customer within
a short period of signing the
murabaha contract, depended on
whether the contract was literally
a deferred payment sale contract
or a financing arrangement. If
it were a sale contract, the total
unpaid murabaha debt (including
the IFI’s costs as well as unearned
profit from financing) would be
owed by the customer to the IFI.
If it were a financing arrangement,
the IFI would be entitled to the
unpaid murabaha cost (the unpaid
principal) only.
The Shari’ah Advisory Council
of Bank Negara Malaysia, to its
credit, is the only major Shari’ah
standards setting body that has
given a definitive fatwa on this
issue in May 2010. It mandates
Islamic banks to include an early
payment discount provision in
BBA and murabaha contracts.
Bank Negara Malaysia is mandated
to set the formula for early
payment discount to alleviate
uncertainties resulting from
omitting this important provision
from the murabaha and BBA
contracts.
In Dubai, the determination by
the court as to whether a leaseto-own
contract was an operating
lease or an instalment sale contract,
determined the identity of the actual
owner of the property (the IFI or its
customer). This in turn determined
the equitable distribution of the
proceeds of the property between
the IFI and its customer. If the
court had held the contract to be
an operating lease contract, the IFI
would have been the owner of the
whole property despite the fact that
the customer had paid substantial
numbers of instalments leading
up to his ownership, leaving only a
few unpaid instalments as a result
of financial distress. The court,
despite the title of lease-to-own,
re-characterised the contract as an
instalment sale.
Recently, an Islamic finance
institution has filed for bankruptcy
in New York, under Chapter
11. Notwithstanding that it is an
Islamic financial institution and uses
various Islamic financing contracts
approved by its Shari’áh board,
it has declared in the bankruptcy
petition that all its customers are
creditors and all its contracts are
‘Bank Loan’ contracts. It has also
classified all mark-ups over its costs
as ‘interest’ and sought to benefit
from the post-petition interest
freeze allowed under Chapter 11.
Most probably the IFI is relying
on the substance over form in its
declaration of bankruptcy.
The new AAOIF standard No.
43 mainly deals with personal
bankruptcies. Section 9 of the
Standard, however, excludes from
the pools of assets available to
creditors, all funds deposited by
Islamic bank customers in saving
and investment accounts. As a
result, in the case of bankruptcy, the
depositors in saving accounts would
have none of the protection granted
to creditors. They would bear
the risk of loss as rab-al-maal or
muwakkil (depending on they have
We need to change the
course and need to articulate
a rational basis, rooted and
derived from the principles of
the Shari’ah for distinguishing
a halal fixed return with capital
guarantee and a haram fixed
return with capital guarantee.
used a mudarabah or investment
wakala contract to place their
deposits). Whether central banks
would allow an Islamic bank to
deny depositors in saving accounts
the same protection as that offered
to current account customers is
questionable. During the financial
crisis of 2008, despite the terms
of the saving accounts in Islamic
banks, no one is reported have lost a
dirham in saving accounts.
After considerable thinking and
reading of the case law and articles,
it is clear that the use of fictitious
contracts is the main source of the
lack of clarity, conflicts and the
credibility deficit in Islamic finance.
Unless the form and substance
is reconciled, it would be very
hard to rationally and consistently
develop and apply the rules of iflas
and i’sar to defaults, distresses and
bankruptcies in Islamic finance.
A Genuine Solution
Wikipedia, after explaining the
meaning of the term Contractum
Trinious as ‘a set of contracts
devised by bankers and merchants
in the Middle Ages as a method
of circumventing canon law edicts
prohibiting usury’ adds that: ‘Some
Muslims are of the view that the
present practice of Islamic banking
relies on devices similar to the
Contractum Trinious as a means
of working around a ban of riba
(usury) in religious scripture’.
Just working around every
conventional financing term sheet
by using multiple trade contracts
is not a genuine Islamic solution.
Reputable Fiqh Academies of
OIC, Muslim World League hold
similar views on some of the
Islamic contracts such as organised
tawarruq and al-inah. In a case
in the U.K. (TID v. Bloom) an
Islamic financial institution has
argued that an investment wakala
contract, approved by its own
Shari’ah supervisory board, was in
reality an interest-based transaction
dressed up as an investment agency
contract.
We need to change the course
and need to articulate a rational
basis, rooted and derived from
the principles of the Shari’ah for
distinguishing a halal fixed return
with capital guarantee and a haram
fixed return with capital guarantee.
There are several reasons why we
have adopted the path of fictitious
contracts in the past. It is possible
to take the view that the only
genuine tool of financing in Islam is
mudarabah or musharakah is wrong.
www.islamic-banking.com IIBI 37