Federal Court’s landmark ruling puts Islamic banks at ease

This article first appeared in The Edge Malaysia Weekly, on April 22, 2019 - April 28, 2019.
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ISLAMIC banks watched with bated breath as the Federal Court made a decision two weeks ago that could have had negative implications on the industry.

On April 10, in a landmark decision, the Federal Court held that findings on Islamic finance by Bank Negara Malaysia’s Shariah Advisory Council (SAC) is binding on civil courts. A nine-member panel of judges, in a narrow 5-4 decision, also ruled that the ascertainment of Islamic law by the SAC does not amount to a judicial decision.

The industry heaved a sigh of relief at the decision, according to Mazura Mohamed Jamil, a director of the Association of Islamic Banking and Financial Institutions Malaysia (AIBIM).

AIBIM, which represents 26 Islamic financial institution members, and Bank Negara were interveners in the proceedings.

“As it turns out, the outcome was in our favour. Had the court ruled otherwise, it would have had an undesired impact on the Islamic banking industry as a whole. That is why AIBIM intervened — to ensure that the judges look at all angles before they decide,” says Maizura, AIBIM’s director in charge of policy, legal product and shariah matters.

The court delivered the decision in a constitutional reference following a dispute between Islamic bank Kuwait Finance House Malaysia Bhd (KFH) and JRI Resources Sdn Bhd, a provider of marine services and related activities.

The dispute stems from a civil lawsuit that KFH filed in 2013 against JRI for the recovery of an outstanding amount of RM118.82 million, over financing agreements that they had entered into in 2008 and 2009. There were four Ijarah facilities agreements and one Murabahah Tawarruq agreement. KFH also made a claim against three guarantors.

In October 2014, the High Court ruled in favour of KFH. JRI then appealed through the Court of Appeal, where it raised the question on whether a clause in one of the Ijarah facility agreements — relating to which party should bear the responsibility and cost of maintaining vessels — was shariah compliant or not. (The vessels were the underlying asset under the Ijarah contract).

The question was referred to the SAC, which made a ruling that, in principle, the owner bears that responsibility. However, the SAC also allows contracting parties to negotiate and decide on who should bear that responsibility.

Still unhappy, JRI then sought a constitutional reference — hence, a matter for the Federal Court — to determine whether Section 56 and 57 of the Central Bank of Malaysia Act 2009 (CBMA 2009), under which the SAC made its ruling, was constitutionally valid. Its lawyers argued that, pursuant to the sections, the SAC usurps judicial power.

“JRI was basically challenging the constitutionality of the establishment of the SAC itself. Those two sections are basically the mandate given by the parliament for the establishment of the SAC. So, if the mandate is challenged, then obviously, there won’t be any SAC,” explains Mazura.

For that reason, AIBIM became an intervener in the proceedings.

“When they challenged, we felt that it was obligatory for us to make sure that the legal infrastructure remained. Having the SAC helps make the Islamic business more stable. Think about it — when it comes to shariah issues, there are so many schools of thought and bodies with differing opinions out there, so if we don’t have a central body governing in Malaysia, things would be so haywire. With so many experts, bank customers who default [on financing] may take advantage by questioning the shariah-compliance of their financing arrangements, causing unnecessary disruption to the system itself, which in turn may result in a systemic risk. So that is why, we were anxious when the question of [SAC’s] constitutionality came up,” she says.

As it turns out, the majority of the Federal Court held that the ascertainment of Islamic law by the SAC does not amount to a judicial decision.

“In a matter where there are differences of opinion regarding the validity of a certain Islamic finance facility, the SAC could be referred to so as to ascertain which opinion of the jurist is most applicable. It is for the courts to apply the ascertained Islamic law to the facts of the case. As such, the final decision in the matter remains with the court in that it has to still decide the rights and liabilities in issues that have been pleaded by the parties,” the court says in a press summary, explaining the reasons for the judgement.

 

Not the first time

This is not the first time a party is challenging the constitutionality of the SAC in the Federal Court. JRI’s was the second, according to Muhamad Nakhaie, a solicitor from J.Lee & Associates,which represented AIBIM.

Tan Sri Khalid Ibrahim was the first to do so, he says. According to past press reports, this was over a suit filed by Khalid against Bank Islam in 2007 over the alleged wrongful disposal of his shares in Guthrie Bhd which he had acquired through an Islamic financing facility in 2001 when he was Guthrie’s CEO.

The bank counter-sued, demanding the return of some RM70 million, claiming that Khalid had breached the financing agreement following his failure to repay. Over the course of events, the matter reached the Federal Court but the proceeding was withdrawn as the two parties reached an out-of-court settlement in 2014.

Nakhaie notes that the decision on the JRI referral this year was significant in that it was heard by a full nine-member bench.

The five who formed the majority decision were Federal Court judges Tan Sri Ramly Ali, Tan Sri Azahar Mohamed, Datuk Alizatul Khair Othman Khairuddin, and Datuk Mohd Zawawi Salleh as well as Court of Appeal president Tan Sri Ahmad Maarop.

The then Chief Justice Tan Sri Richard Malanjum (he retired on April 12), Chief Judge of Malaya Tan Sri Zaharah Ibrahim, Chief Judge of Sabah and Sarawak Datuk Seri David Wong Dak Wah and Federal Court judge Tan Sri Idrus Harun dissented. “The effect of [Section 57] is to vest judicial power in the SAC to the exclusion of the High Court on shariah matters. The section must be struck down as unconstitutional and void,” Malanjum said in a summary of his judgement.

JRI counsel Datuk Malik Imtiaz Sarwar said: “Though the majority of the court upheld the validity of the provisions, the strong view of the minority is reason enough for the attorney general and the government to consider whether the legislative framework should be amended.”

“The Chief Justice noted that there are other methods by which certainty can be achieved that do not impinge on judicial power. This is something that should be seriously looked at,” he told reporters.

The majority held that the rulings by the SAC constitute an expert opinion in the matters of Islamic finance. “The SAC members are highly qualified in the fields of shariah economics, banking, law and finance,” says Justice Zawawi, who wrote the majority judgement.

The SAC was set up in May 1997 as the highest Shariah authority in Islamic finance in Malaysia. Under the CBMA 2009, the role and functions of the SAC was further reinforced — it was accorded the status of the sole authoritative body on shariah matters pertaining to Islamic banking, takaful and Islamic finance.

 

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