The Kuala Lumpur Regional Centre for Arbitration (KLRCA) recently launched an adapted set of its Arbitration Rules for Islamic arbitration at the 2012 Global Islamic Finance Forum.

The new rules are referred to as the i-Arbitration Rules (the Rules) and will aim to allow for the resolution of disputes arising from any contract that contains Shariah (Islamic Law) issues (the “i” prefix being a well-recognised indication of Shariah compliance).  The aim behind the Rules is to provide arbitration that is suitable for international commercial transactions premised on Islamic principles, which Rules will be recognised and enforced internationally.

The Rules introduce modifications to the July 2012 2nd edition of the conventional KLRCA Arbitration Rules which, in turn, adopt the UNCITRAL Arbitration Rules 2010. The KLRCA Islamic Model Arbitration Clause provides that “[A]ny dispute, controversy or claim arising out of a commercial agreement which is based on Shariah principle or the breach, termination or invalidity thereof shall be settled by arbitration in accordance with the KLRCA i-Arbitration Rules“.

A new provision in Rule 8 provides that wherever the arbitral tribunal has to “[f]orm an opinion on a point related to Shariah principles; and [d]ecide on a dispute arising from the Shariah aspect of any agreement which is based on Shariah principles“, the tribunal must refer the matter to one of the two Shariah Advisory Councils in Malaysia.  If the issue is beyond the purview of the Malaysian Shariah Advisory Councils (which means, according to Guide to the Rules in Part IV of the Rules (the Guide), that the matter or issue referred does not fall within the scope or jurisdiction of the Advisory Councils), it must be referred to a Shariah specialist council or expert agreed by the parties.

The tribunal shall then adjourn the arbitration proceedings until the ruling has been given or, in the meantime, deliberate on other areas of the dispute which are independent of the Shariah issues in the reference.  The council or expert will deliver the ruling within 30 days from the date of the reference and the tribunal must then apply it within 15 days.  The costs of the reference incurred by the tribunal are included in the “arbitration costs”.

Like other countries that embrace Shariah principles such as Bahrain, Indonesia, Hong Kong, the Philippines, Qatar and the UAE, Malaysia has its own Shariah Advisory Councils.  One Council is established by the Central Bank Act 2009 and the other Council is established by the Securities Commission under the Securities Commission Act 1993.

The KLRCA director, Datuk Sundra Rajoo, stated in an article in Global Arbitration Review that “awards under the i-arbitration rules will be enforceable in the 146 countries that are signatories to the New York Convention”.

The new Rules are expected to increase the scope for cross-border Shariah based commercial transactions and respond to the increasing number of Islamic finance parties relying on arbitration to resolve their disputes.  One of the positive implications of the Rules and its referral process for Shariah issues or matters is that they demonstrate that the parties are able to refer disputes under their Shariah compliant agreements to a non-Muslim tribunal (which is confirmed in the Guide).

Some uncertainties remain as to how the Rules will work in practice. The wording in Rule 8 determining the situation in which a tribunal is obliged to refer a matter to the relevant Council (or, as it may be, a Shariah expert) is broad. As such, it may provide scope for parties to argue (either during the reference or, indeed, after an award has been rendered) about whether a tribunal has made a reference (or failed to do so) in accordance with the Rules.  It will be interesting to see at what stage a tribunal’s obligation to refer under Rule 8 “kicks in”, for example, in a case where there is a Shariah compliant agreement governed by English law but in which the parties have expressly agreed it should be interpreted in accordance with the Islamic principles of Shariah.  In such a situation, it will fall to the tribunal to determine if and how the obligation to interpret the agreement in accordance with Shariah law is to be divorced from determination of a dispute arising under it. Whilst it is clear under Rule 8.6 that the Council or Shariah expert “shall not have any jurisdiction in making discovery of facts or in applying the ruling or formulating decision relating to any fact of the matter which is solely for the arbitral tribunal to determine”, in practice there may be some tension in a process that seeks to utilise both a tribunal and a Shariah Council or expert.

A further consideration yet to be explored is confidentiality.  Rule 13 obliges the tribunal, parties and KLRCA to keep confidential all matters relating to the arbitration proceedings.  It does not extend to the Council or expert. This could potentially be remedied by the tribunal including an obligation of confidentiality in its reference to the Council or expert.

Against the backdrop of the Arbitration Amendment Act 2011 (which sought to highlight the support for arbitration from the Malaysian courts by virtue of their non-interventionist position), with the introduction of the revised KLRCA Arbitration Rules in July 2012 and the i-Arbitration Rules, the KLRCA is taking considerable strides to establish itself as a rival to the arbitration centres in Hong Kong and Singapore.

Time will tell whether, by introducing the i-Arbitration Rules, the KLRCA is meeting an unmet need amongst parties to transactions based on Islamic principles of Shariah. However, the new Rules are a helpful contribution to the arbitral options available and their introduction should help support Kuala Lumpur’s ambition to be a hub for Islamic finance in the region.

Nadim Khan, Herbert Smith Freehills’ Global Head of Islamic Finance, explains, “[w]e welcome the new rules providing for international arbitration, which will help Malaysia to promote the internationalisation of Islamic finance.  The rules will increase the scope for cross-border Shariah based commercial transactions“.