A lawyer faces many challenges when preparing documentation for Islamic banking. For the purposes of this article, these can be classified into three types: (i) operational issues; (ii) legal issues; and (iii) Shariah issues.
Operational issues
In terms of operational issues, a lawyer must fully understand the particular products in question and the Shariah concepts used before commencing to draft the documentation. This is important as different products have different terms and conditions.
Similarly, different Shariah concepts used for a particular Shariah product will result in different terms and conditions.
Legal issues
As our Islamic banking is still under the jurisdiction of the civil court, the practitioner must also ensure that the financing documentation prepared complies with civil law.
In other words, the documentation must conform to contract laws (including but not limited to the Contracts Act 1950) and banking laws and regulations (including but not limited to the Banking and Financial Institutions Act 1989 and Islamic Banking Act 1983).
Shariah issues
These include:
- Terminology used – With regard to documentation for Islamic banking, a lawyer must scrutinize the terminology used. For example, it is not accurate to use the terms “borrower”, “loan”, “loan amount”, “interest”, “interest rate”, “default interest” and “loan agreement”. The more appropriate terms are “customer”, “financing”, “financing amount”, “profit”, “profit margin”, ta’widh (compensation) and “financing agreement”.Likewise, the terminology used must also reflect the particular Shariah concept applied for the product in question. For example, it is not appropriate to use “commission” in the documentation for a product using the concept of Murabahah. In this concept, there is no element of services rendered by the financier.
- Elimination of any element of riba – The documentation must be free from any element of riba. Riba literally means increase, addition, expansion or growth. In the Shariah, riba technically refers to the “premium” that must be paid by the borrower to the lender along with the principal amount as condition for the loan or for an extension in its maturity.This definition covers the terms “interest” and “default rate” under conventional banking.In addition to the verses of the Holy Quran previously mentioned, Allah says:
“O those who believe, fear Allah and give up whatever remains of riba, if you are believers.” [Al-Baqarah 2:278] - Elimination of any element of gharar – Reliable sources have reported through a number of Prophet Muhammad (peace be upon him)’s companions that the prophet forbade gharar trading.
Literally, gharar means risk or hazard. Al-Sarakhsy defines gharar as “situations where consequences are concealed”.In other words, gharar covers cases of doubtfulness or uncertainty and the unknown. Shariah jurists agree that that the gharar which affects the contract is excessive gharar and that slight gharar has no impact at all.Among the examples of contracts laden with gharar that impair the validity of the contract are deferment of the price to an unknown future date, sale of objects not owned by the seller, contracting on a non-existent object (save in the case of Salam financing and Istisna’ financing) and lease contract, where the rental is unknown and unidentified. - Underlying assets used must be permissible assets – Contracts in Islamic banking are permitted only when the underlying assets involved (if any) are permissible assets. For example, sales of alcohol and pork are not permitted.Allah says in the Holy Quran:
“O you who believe! Intoxicants and games of chance and (sacrificing to) stones set up and (dividing by) arrows are only an uncleanness, the Satan’s work; shun it therefore that you may be successful.” [Al-Maidah: 90] - Compliance with principles of contract under Shariah – The documentation for Islamic banking must also comply with the principles of contract under Shariah. For example, in cases of financing involving sale (Bai’), the documentation must reflect the true nature of a sale (Bai’) contract.
In conclusion, it is a challenging task for a lawyer to prepare documentation for Islamic banking. In addition to legal practitioner, he must wear the hat of banker and Shariah compliance officer.
Mohd Herwan Sukri Mohammad Hussin is an associate at Azmi & Associates, Kuala Lumpur. He can be contacted at +603 2118 5061 or via email at
[email protected]