The recent case of The Investment Dar Company KSCC ("TID") and Blom Developments Bank ("Blom") has caught the attention of the Islamic finance sector. In summary, TID defended a claim under a wakala agreement on the basis, inter alia, that the arrangement was not Shari'ah compliant, was therefore not a transaction that TID was permitted by its Articles of Association to enter into and, as a result, was void. The English High Court decided TID should be allowed to run this argument at trial. While much has been made of the wider implications of TID's defence ultimately succeeding, it is important to note that the judgment does not finally decide this point, but rather reserves it for a later day. That said, the Islamic finance sector will be watching how the case develops with keen interest.

Background to the case

In 2007, TID and Blom entered into a master wakala (a type of Islamically compliant investment instrument) contract, and subsequent individual contracts, pursuant to which TID as wakeel would invest monies deposited by Blom, the muwakkil, and would pay Blom a specified rate of return irrespective of the results of the investments.

The contract is governed by English law. In the contract, TID (i) confirms that the terms of the master wakala contract and the transactions contemplated thereby are in accordance with the Shari'ah as interpreted by the Shari'ah committee and (ii) undertakes that it will not at any time assert that any provision of the contract or any transaction effected pursuant thereto contravenes the Shari'ah.

The investments made by TID were not successful and TID stopped making payments contemplated by the wakala arrangements to Blom. Blom sued TID for repayment of the amounts it had invested as well as the specified rate of return profit element, based on (i) the contract itself, which obliged TID to make payments to Blom (the "contract claim"); and (ii) a breach of trust arising as a result of the agency relationship between TID and Blom (the "trust claim").

Blom applied for summary judgment and, at first instance, it was granted summary judgment on its trust claim, TID was therefore ordered to repay all the principal sums but not the specified profit. TID appealed the summary judgment decision. Blom asserted that it should have been awarded summary judgment on both its contract claim and its tort claim.

Summary judgment (appeal)

On appeal, the English High Court was asked to decide whether TID had grounds for defending the claim that were sufficiently arguable so as to justify a full trial. The judge decided that TID had an arguable defence on both the trust claim and the contract claim and therefore allowed the appeal.

In doing so the judge upheld the first instance decision that TID had an arguable case that the wakala arrangement was ultra vires because (i) TID's articles of association did not permit it to make non-Shari'ah investments and (ii) it was at least arguable that the wakala arrangement in question was not Shari'ah compliant.

The judge also decided, contrary to the first instance decision, that TID had an arguable case on the trust claim. Therefore, both the contract claim and the trust claim will now proceed to trial, scheduled to take place in July 2010.

However, the judge noted that even if the wakala transactions were ultra vires and therefore void, Blom would have a restitutionary claim because it would have mistakenly paid money under an invalid agreement. Therefore, the judge was of the view that "one way or another Blom is bound to succeed".

Importantly, the case did not decide that TID's defence - either to the contract claim or the trust claim - will succeed, let alone that wakala arrangements are not Shari'ah compliant. Interestingly, the Shari'ah defence was only put forward at the eleventh hour lending some credibility to the view that this was perhaps more of a strategic move. Rather, the case decided that TID had raised arguable issues that ought to be explored at trial. Establishing that there is an arguable case for the purposes of a summary judgment application in the English courts is not unduly difficult - a party has to simply show that its prospect of success are not merely fanciful. The case should not, therefore, cause undue alarm to the Islamic finance industry, although the next stages of the case will be followed with interest.

Going forward – how to prevent a counterparty from invoking a non-Shari'ah compliance defence

One should not just rely on a Shari'ah board to approve the transaction. A number of steps should be taken to prevent a party to a contract purporting to be compliant with Shari'ah principles, from invoking a non Shari'ah compliance defence or to guard against a defence such as that in the TID case being raised:

  • Check the objects clause in the Articles of Association and make sure the transaction is within the objects of the company and if necessary arrange for any appropriate amendments to be made;
  • Include a representation regarding the objects clause in the contract;
  • Include a Shari'ah undertaking in the form of an explicit waiver of any defence of non compliance;
  • Require each party to obtain its own independent Shari'ah expert advice and a fatwa (opinion on Shari'ah matters) if appropriate; and
  • Ensure that the contractual clauses dealing with choice of law and jurisdiction provide the best possible protection against anticipated default or enforcement issues.

To read the full text of the case, please click here.