In some jurisdictions, if a company enters into a transaction beyond the powers set out in its incorporation documents, that transaction may be void with the consequences that obligations connected to the transaction may be unenforceable. The recent dispute on a Wakalah agreement between Blom Development Bank and The Investment Dar (TID) is an example of such a situation and the potential impact this may have on Islamic finance.
Blom is a reputed financial institution incorporated in Lebanon. It placed US$10 million as an investment with TID under a Wakalah agreement on the 11th October 2007. Governed by English law the agreement’s basic terms provided for a return of the capital invested and the pre-agreed profit to Blom at the end of the contracted period, which has not been disclosed.
The Wakeel, TID incorporated in Kuwait, is engaged in a range of Shariah compliant investment activities and consumer finance services in Kuwait and abroad. According to industry sources, TID’s activities comprise finance, banking, real estate, investment and asset management, as well as other related services. At the end of the contacted period, TID failed to honor its obligations towards Blom, which amounted to US$10,733,293. Blom was granted a summary judgment that TID needs to pay only the capital investment. TID was concerned about the impact this court decision might have on its restructuring plans, hence it appealed to the English High Court.
At the appeal, TID argued that it was prohibited by its constitutional documents from entering into any agreement which does not comply with Shariah and argued that the agreement with Blom is one such instance. So, the Wakalah agreement with Blom was beyond its corporate powers and therefore void, it submitted.
According to legal practitioner Michael Rainey of King & Spalding, there are two important factors to be noted. “Notwithstanding the court finding in favor of TID, the court held that even if at a full hearing the agreement was found to have been entered into beyond the corporate powers of TID and therefore void, Blom would be successful in a claim for restitution which would entitle Blom to the return of at least the capital sum. The court, therefore, ordered TID to pay Blom the capital sum but not the profit.
“Secondly, TID is currently in negotiations with its creditors to restructure its debt without the protection of a defense against creditors bringing proceedings against it. (Therefore) TID may have had to resort to a defense it would not otherwise have raised,” he said.
According to the memorandum of association of TID, the company’s objectives should be Shariah compliant. All Islamic financial institutions (IFIs) are bound by Shariah compliancy and self-constraining constitutional documents. By arguing that an agreement is not compliant with these conditions and therefore not honor it would leave a debtor in a difficult position while potentially scarring off future investors. The argument put forward by TID in this case could create a negative impact on the Islamic finance sector at large. According to industry sources, parties engaged in Shariah compliant financing transactions with Islamic financial institutions have been sensitive to the “Shariah risk,” where an executed transaction could later be viewed by a Shariah advisor as not being in compliance with Shariah.
“Concerns over such a risk became more pronounced after Sheikh Taqi Usmani’s well publicized 2008 statement that a large number of existing Sukuk transactions were not in compliance with Shariah,” said Rainey. “Having an IFI itself use non-compliance with Shariah as a defensive weapon — to claim that the transaction it entered into was with the full knowledge that its terms were not Shariah compliant and therefore not binding on itself —increases so-called Shariah risk by several degrees. Moreover, the willingness to make such an argument damages the credibility of IFIs in general.”
During the appeal, High Court judge Purle held that a clause in the disputed Wakalah agreement confirms TID’s Shariah committee was satisfied that the range of transactions undertaken by the company was Shariah compliant. Rainey said: “One wonders if the Shariah committee was advised about the defense raised by TID in this case.”
Clause 5 of the disputed Wakalah agreement contradicts TID’s argument of having executed a non-Shariah compliant agreement. It states: “The Wakeel shall not utilize the Wakalah assets for any other purpose except what is permitted by Muwakkil (the depositor/investor) and within the Shariah parameters. The Wakeel confirms that the terms of the master Wakalah contract and the transactions contemplated hereby are in accordance with the Shariah as interpreted by the Shariah committee and it undertakes that it will not at any time assert that any provisions thereof or any transaction effected pursuant hereto contravenes the Shariah.”
The judge said: “It is said on behalf of TID that the contract amounted to a non-compliant Shariah transaction because, in reality and substance, what TID was doing was taking deposit at interest. Blom says that claim is nonsense. It points to the undoubted fact that the Shariah committee of respected scholars had authorized and approved of this form of contract, which is a strong indication that the contract was indeed Shariah compliant.”
He also held that the reason for TID’s non-payment is that its investment activities have not been as successful as it had hoped and anticipated and that it has encountered serious cash flow problems.
In view of this dispute, Rainey offers four factors for an investor or financier to take into consideration when entering into an agreement with an IFI:
• The IFI delivers a certificate of its Shariah committee, or internal Shariah advisor, confirming that the transaction is Shariah compliant.
• The deletion of any prohibition in the constitutional documents of the IFI which prohibits that IFI from entering into agreements which do not comply with Shariah.
• A representation to be inserted into the Shariah compliant agreement stating that entry into and performance by the IFI of that agreement does not conflict with any of its constitutional documents.
• The waiver by the IFI of any defenses that it may have in connection with the agreement not being compliant with Shariah principles.