United Arab Emirates: UAE Laws and Islamic Sharia: Some Practical Issues

The laws of the UAE and DIFC are designed to support the use of Islamic finance but in practice there are various issues regarding the practical implementation of Islamic Sharia which arise. Alan Rodgers highlights some of these issues.

In brief:
  • Various issues exist with regards to the practical application of Islamic Sharia'a doctrines in Islamic Finance transactions in the UAE.
  • Governing law and Islamic Sharia, in some instances are incompatible and care should be taken where Islamic Sharia is stated as prevailing over governing law.
  • The capacity of Islamic Institutions is a risk that needs to be addressed following the recent TID v Blom Development Bank case.

The basis and context of UAE law and Islamic Sharia within contracts

Articles 1, 2 and 3 of The Federal Civil Code incorporate aspects of Islamic Sharia and Islamic jurisprudence into the framework of law governing the UAE. The law states that, in the first instance, governing law should be applied, failing which, principles of Islamic Sharia should be relied upon. The Civil Code also addresses most of the recognised Islamic Sharia contractual instruments such as; Ijara, Wakala, Mudaraba and Salam, and provides guidance on legal issues such as gambling, betting and interest, and legislates accordingly in the context of civil and commercial circumstances and public policy.

Governing law and Islamic Sharia principles

A practice has crept into Islamic documentation which sometimes provides that where there is a conflict between governing law, Islamic Sharia principles will prevail. This practice should be avoided as it creates an unnecessary conflict between legislation and doctrines which might destabilise a contract.
In practice, there can only be one governing law. To say that Islamic Sharia also governs or takes precedence over governing law is illogical because the governing law is fixed and cannot be superseded by doctrines. Islamic Sharia is governed by several doctrines and the application of these doctrines is dependant on the various interpretations to which differing groups of Islamic scholars subscribe.
UAE Islamic finance institutions (IFIs)

In the UAE, IFIs are regulated by the UAE Central Bank. Under Law No. 6 of 1985, IFIs are permitted to carry out commercial, industrial and trade activities, acquire real estate, receive deposits and invest in funds all on their own account. Under their memo and articles, they must have a Sharia supervisory board of no less than three members.
Central Bank resolution 165/6/2004 contains a number of provisions intended to regulate the activities of Islamic institutions, for instance an IFI can subscribe for shares and sukuks or finance an entity or person up to a maximum of 7% of its own capital unless the Central Bank gives approval to exceed this limit.
Islamic finance in practice: areas of uncertainty

There are some areas, in practice, which illustrate uncertainties between UAE law and Islamic Sharia principles and some of these instances are referred to below:
  • Interest: Charging interest is not permitted under Islamic Sharia, however, under Article 76 of the Commercial Code, it is permitted.
  • Hedging and gambling: Gambling is prohibited in the UAE, but debate continues over whether derivatives and other exotic banking products are Islamically acceptable and enforceable under UAE law.
  • Sukuks or Commercial Bonds: Most practitioners consider sukuks to be equity rather than debt based instruments, however, in practice there have been examples of sukuks dressed up to look like bonds to accommodate international investors. If the sukuk is considered to be a bond then it is likely to be caught by Articles 179 – 180 of the UAE Companies Law which imposes material restrictions on the issuance of bonds and debentures.
  • Ijara or real estate lease? Some UAE courts appear to be unclear as to whether Ijara used in residential Islamic financing is a finance instrument or a real estate instrument. If they are the latter, the issue arises as to whether it is void for lack of registration at the land registry.
  • Forward leases: Different doctrines of Islamic Sharia either permit or forbid forward leases. In conventional terms a forward lease is a lease for un-built property. Under some Sharia doctrines an un-built property cannot be enjoyed by a lessee and therefore cannot be granted.
  • Islamic finance in the courts – capacity risk: The English court case of TID v Blom Development Bank recently highlighted the dangers of IFIs who claim that they lack capacity to honour their debts. In this case, TID claimed that to uphold a wakala that it had entered into with Blom would be un-Islamic and a breach of its statutes. This case raises a number of issues, not least the value of an IFI's fatwa as issued by its Sharia supervisory board, which TID had obtained. It highlights that a fatwa may be simply disregarded if the entity in question maintains that the instrument is ultra vires its statutes.
  • Tier 2 Capital issues: In relation to Tier 2 capital financing where IFIs are the recipients of funds, the issue is how to treat such funding if it is deeply subordinated and convertible. Would it be treated as capital or debt? The answer is unclear in the UAE but in practice, a wakala may be considered appropriate by some IFIs to evidence tier 2 capital funding but this is largely dependant on the IFIs Sharia supervisory board opinions.
DIFC laws: untested legal framework

The Dubai Financial Services Authority (DFSA) has in place an Islamic Sharia legal regime underpinned by the Law Regulating Islamic Financial Business, but it remains to be tested. To this date, there are no reported decisions.

The laws of the UAE and DIFC are more supportive of Islamic Sharia in comparison for instance to English law, because such laws are either based on Islamic Sharia principles or contain specific rules for Islamic Sharia compliance. However, a reccurring issue in Islamic financing in the UAE is the apparent lack of homogeneity between different schools of Islamic doctrines and their Sharia boards' idiosyncratic approach to some aspects of Islamic financing such as the use of instruments like murabaha and wakala, coupled with the lack of conformity between governing law and Islamic Sharia principles.