EXPERIENCIA DE TITULIZACIÓN EN INFRAESTRUCTURAS Y SERVICIOS PÚBLICOS 135

1.4.1 Legal Uncertainty

In Vallejo v Wheeler, Lord Mansfield emphasised the importance of legal certainty by saying, “In all mercantile transactions the great object should be certainty; and therefore, it is of more consequence that a rule should be certain than whether the rule is established one way or the other. Because speculators in trade then know what ground to go upon”.56 As legal systems are meant to facilitate business activities and promote economic efficiency, certainty in law enables the participants of the market to make a fully-informed decision regarding their business call.57 It also has a role to ensure that courts resolve disputes according to established legal norms and act in a legitimate manner by, inter alia, limiting arbitrary judicial decision- making.58 On the contrary, uncertainty in law would blur the boundary between what is permitted and what is otherwise which is likely to affect the incidence of unlawful activity and subsequently, might result in higher litigation and judicial system costs.59

Islamic finance is no exclusion from the need for legal certainty. As mentioned above, the validity of the financial products offered under Islamic finance is highly depending, inter alia, to the legal and regulatory framework that applies in their case. It is such framework that shall determine, for instance, the true nature of the products in question thus validate which set of rules is to be invoked, especially if the matter is being brought before the court of law for adjudication. As shall be explained later, the uncertainty in this regard has been causing legal complexity and puts the involved parties at certain uncalled situations such as unable to recover the supposedly due debt amount since the financial product used in the financing facility is deemed as ‘unrecognised’. In the case of Malaysia, the question of legal certainty in Islamic finance matters becomes a matter of concern due to the reality of its legal landscape. Malaysia is a country which runs dual legal systems that work side by side. At one end, there is the Islamic legal system in place which operates Shariah-based legal regime through the Shariah courts. At the other end, the country is also governed by the legal regime which adopts the English common law system as a result of the long British colonisation history. The civil courts (the Shariah courts’ counterpart), therefore, shall try the cases brought upon them according to the relevant Malaysian English-based laws. The Federal Constitution, as

56 _{[1774] 1 Cowp 143}

57 _{Iain MacNeil, ‘Uncertainty in Commercial Law’ (2009) 13(1) Edinburgh Law Review 68} 58 _ibid

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the supreme law of the land, has explicitly allocated each of these courts with their jurisdiction. While the jurisdiction of the Shariah courts is relatively limited and can only handle the cases which involve only person who professes the religion of Islam (Muslim), all cases related to banking matters and commercial transactions, including the cases of Islamic banking and finance, fall under the purview of the civil courts. As such, notwithstanding the fact that Shariah (particularly Islamic commercial law known as Fiqh Al-Mualamalat) is at the heart of Islamic finance, in the Malaysian context, all its dealing shall be governed by the common law framework rather than Shariah law framework. (Chapter 4 will engage this point with deeper deliberation).

The reality as mentioned above (Islamic finance dealing is to be governed by the English Law) has been causing legal complexity as what can be observed in a number of cases involving Islamic finance dealings from all around the globe. One of these cases is Beximco Pharmaceuticals Ltd & Ors v Shamil Bank of Bahrain.60 In this case, which had reached the Court of Appeal, the appellant appealed against the summary judgement of the High Court which was in favour of the plaintiff (Shamil Bank of Bahrain, SB) regarding its debt recovery. In summary, SB had entered into various Islamic financing agreements (they are mainly based on the cost-plus sale, Murabahah) with the first defendant (Beximco Pharmaceuticals Ltd, BP) and the second defendant as the principal debtors for the purpose of advancing credit facilities. The financing agreements contained, inter alia, the governing law clause which reads “subject to the principles of Glorious Shari’a [Shariah] this agreement shall be governed by and construed in accordance with the laws of England”. As defendants defaulted the

payments under the agreements, SB sought to enforce them. Although the amount being claimed is not in dispute, the defendants had advanced several defences including their contest on the availability and the enforceability of the agreement. According to them, by virtue of a true construction of the governing law clause, the agreements were only

enforceable in so far as they were valid and enforceable in accordance with the principle of the Shariah and accordance with the English Law. They further argued that although the facilities invoked the Shariah-compliant contract, they were merely ‘a disguise for an otherwise undocumented interest-bearing loan'. Since the agreements entail the payment of interest (Riba) which clearly offended the Shariah law, thus they are not enforceable. The judges of the Court of Appeal, however, had unanimously affirmed that the summary judgement was given by the High Court and thus dismissed the appeal. They held, inter alia,

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that there could not be two governing laws for the agreements and as for the case in question, the governing law was the law of England. The phrase ‘subject to the principles of Glorious Shariah' should be taken on a basis which was reconcilable with the purpose of having the agreement, not to defeat it. Furthermore, notwithstanding the possibility of incorporating provisions of foreign law as terms of a contract, the general reference to Shariah, in this case, did not specify which aspect of it was intended to be incorporated into the contract (since the principles of Shariah, generally, are broad). Rather, it should be understood merely as a reference to the fact that SB held itself out as conducting its businesses according to the Shariah principles. Hence, such a reference stands unqualified, inevitably repugnant to the choice of the English Law as the law of the contract and render the clause in which the phrase was inserted as meaningless.

What can be observed from this case is that the principles of the English Law are not always consistent with the Shariah and the court may not be able to apply both the English Law and the Shariah simultaneously. The conflictive situation, either within the same legal system or between different legal systems, renders uncertainties in the application of law.61

The Malaysian Court of Appeal case, FLH LCT Services Sdn Bhd & Anor v Malaysian Debt Ventures Bhd62 _{can also exemplify that there are some serious issues in the way how the} common law addresses the Islamic banking cases. In this case, the respondent had granted the first appellant with the credit facility up to RM9.5 million under the Bai Al-Inah contract. Via this contract, the respondent agreed to sell its asset to the first appellant at RM14,233,200 the price of which to be paid in stages and it will be repurchased by the respondent for RM9.5 million, subject to the terms and conditions contained in the various documents. As the first appellant defaulted the payment, the respondent (the plaintiff) prayed to the High Court, inter alia, for the recovery of the sum of RM12,139,615.23 which was due and payable. In their defence, the appellants (the defendants) claimed, inter alia, that the transactions entered into between the plaintiff and the defendants were not in line with the Shariah, tainted with the element of usury which was clearly prohibited by the Shariah law and contrary to the spirit and intent of the financing concept based on Bai Al-Inah. In its decision, the High Court allowed the plaintiff’s claim against the defendants and therefore ordered the defendants to pay RM12,139,615.23 together with other granted payments. The defendants, being

dissatisfied with the decision, appealed to the Court of Appeal against the whole decision.

61 _{Syed Adam Alhabshi, ‘Introducing the Shariah Investment Agreement: Compatibility with Common Law’}

(Doctoral thesis, The International Centre for Education in Islamic Finance (INCEIF) 2016) 4

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After the deliberation, the Court of Appeal found that the failure to mention the asset in the Bai Al-Inah transaction had violated its entrenched principles and therefore rendered it Shariah non-compliant. According to the Court, as it is not recognised as Bai Al-Inah financing contract but something else unknown in the Shariah financing system, the remedy sought is also elsewhere and not under the Bai Al-Inah financing system. Therefore, the previous order by the High Court which includes the payment of RM12,139,615.23 was hereby set aside.

Without having to go deeper into the factual background of the case, what has been

mentioned above would suffice to illustrate the severe risk posed to the financial institution. As the Court in this case failed to recognise the sought-after remedy even though the mode of financing used is well known to both Islamic finance and Malaysian courts (based on the fact that Bai Al-Inah was the financing method predominantly used during the inception of Islamic finance in Malaysia in the 1980s and a number of cases involving it had been brought to the court since then), the financial institution was put in a difficult situation where the attempt to collect the principal sum that it had initially disbursed to its customer is interrupted.

1.4.2 Conflictive Nature of Islamic Finance: An Overview of Musharakah as a Risk- Sharing Vehicle in Malaysia

Earlier in this chapter, it is asserted that risk sharing is the cornerstone of Islamic finance and the existence of risk is essential in all Islamic commercial transaction which aims to generate profit. Nevertheless, the reality of the Islamic finance industry in this respect rather illustrates a contrary situation. Some had argued that even though risk sharing is idealised in Islamic finance, in reality, it is seriously marginalised in the IFIs.63 Rather, Murabahah (the cost-plus sale) has always been predominantly used as it ensures maximum risk avoidance with a relatively high return.64 The IFIs, the argument went on to say, have quietly disengaged from risk sharing modes and embraced the Murabahah syndrome; the strong and consistent

tendency of Islamic banks and financial institutions to utilise debt-like instrument.65 Although Murabahah-based financing might still be considered as Shariah-compliant, it implies a totally different position in terms of the risk profile which does not conform to the idea of risk sharing. It is because the risk involved in this mode of financing is arguably in existence and

63 _{Mohammad Omar Farooq, ‘Partnership, Equity-Financing and Islamic Finance: Whither Profit-Loss Sharing?’}

(2007) 11 Review of Islamic Economics 67

64 _ibid 65 _ibid

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negligible as a result of its documentation construction which eliminates the IFIs from all liabilities.66 Therefore, it can be said that the sale executed in Murabahah financing is nothing more than creating indebtedness to sugar coat the arrangement whereby in the real sense, it is akin to the Riba-based loan with no involvement of risk (in Chapter 3, the steps involved in Murabahah-based financing shall be explained).

Such a disengagement is also illustrated by the statistic of Malaysian Islamic financing

composition based on the Islamic contract used issued by the Central Bank of Malaysia (Bank Negara Malaysia, BNM) in its 2017 issuance of the Financial Stability and Payment Systems Report.67 As shown by the statistic, financing that takes Musharakah (equity-based) as its underlying contract was relatively small as compared to the financing that takes the debt- based contract as its underlying contract; the former represented 9.2 per cent of the total financing size whereby the latter represented 78.3 per cent of the total financing.68 This further implicates the existence of a serious gap between the theoretical approach which dominates the Islamic finance literature that propagates risk sharing as the backbone of the Islamic finance, and the practice of the Islamic finance institutions which conforms with the status-quo of the conventional banking practice that heavily relies on the debt-

basedarrangement for the provision of finance.

Looking from the perspective of the Malaysian legal and regulatory framework, a similar dichotomy can be observed as well. At one end, the Islamic Financial Services Act 2013 (IFSA 2013) construes Musharakah and Musharakah Mutanaqisah as equity or partnership financing. However, the Musharakah Regulatory Policy issued by BNM which provides, inter alia, regulatory framework pertaining to the Musharakah operation in Malaysia explicitly provides Musharakah Mutanaqisah, particularly with the purpose of asset acquisition (as in home financing product), shall reflect a debt-based financing risk profile. Since both equity and debt financing modes connote contradict meanings and render opposite impacts on their risk profile (as shall be further discussed in this study), the contradictory positions held between the IFSA 2013 and the Musharakah regulatory policy in this respect, may potentially lead to the uncertainty in law as mentioned above.

66 _{Ahamed Kameel Mydin Meera and Dzuljastri Abdul Razak, ‘Islamic Home Financing through Musharakah}

Mutanaqisah and al-Bai Bithaman Ajil Contracts: A Comparative Analysis’ (2005) 9(2) Review of Islamic Economics 5

67 _{Bank Negara Malaysia, ‘Financial Stability and Payment Systems Report 2016’ (March 2017) 91}

68 _{As for debt-based financing, the breakdown is as follows; BBA-12 per cent, Bai al-Inah-7.2 per cent, Tawarruq-}

22.4 per cent, Murabahah-18.7 per cent and Ijarah-18 per cent. The rest 12.5 per cent consist of unspecified Islamic contracts such as Bai al-Dayn, Bai al-Salam, Bai al-Sarf, Istisna, Mudharabah, Kafalah, Qard, Rahn, Ujrah and Wakalah.

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Also, as shall be explained later in this study, the introduction of Musharakah Mutanaqisah in Malaysia as a method of financing, was motivated by the desire to depart from the BBA- based financing (which may also be referred to as the Murabah-based home financing) since the latter resembles the features of debt financing which akin to riba-based financing. As such, the failure to ascertain the true nature of Musharakah and Musharakah Mutanaqisah may become a major setback to the development of Islamic finance and pose the reputational risk under the impression of misleading. Furthermore, the products might not be correctly recognised by the court of law since its true nature, as far as the current legal and regulatory frameworks are concerned, is yet to have a solid characterisation. Assuming such an event is to take place, the occurrence of problem pertaining to the sought-after remedy as what had been seen in the case of FLH LCT Services Sdn Bhd & Anor is not something far-fetched. Based on the problematic circumstance and its potential effects as mentioned above (the uncertainty of the Musharakah product’s nature due to the uncertainty within the legal and regulatory framework which is counterproductive to the development of Islamic finance in strengthening risk sharing in Malaysia as well as posing the reputational risk) it is important for a study to be undertaken in this respect to evaluate the current position of the Malaysian legal and regulatory framework vis-à-vis Musharakah, particularly on the question of the framework’s consistency with the implementation of risk sharing through Musharakah.