THE APPLICABILITY OF MALAYSIA'S FEDERAL COURT RULING ON THE AUTHORITY OF SHARIAH ADVISORY COUNCIL IN CIVIL DISPUTES TO ARBITRATIONS ON ISLAMIC FINANCE AND CAPITAL MARKETS

The Central Bank of Malaysia Act 2009 ("Act") designated Malaysia's Shariah Advisory Committee on Islamic finance ("SAC") as the authority for ascertaining Islamic law for the purposes of Islamic financial business. According to Section 2 of the Act, "Islamic financial business" encompasses "any financial business in ringgit or other currency which is subject to the laws enforced by the Bank and consistent with the Shariah".

On 10 April 2019, Malaysia's Federal Court – by a five to four majority – upheld the validity of Sections 56 to 58 of the Act.[1] These provisions read as follows:

56. Reference to Shariah Advisory Council for ruling from court or arbitrator

• Where in any proceedings relating to Islamic financial business before any court or arbitrator any question arises concerning a Shariah matter, the court or the arbitrator, as the case may be, shall–
  • take into consideration any published rulings of the Shariah Advisory Council; or
  • refer such question to the Shariah Advisory Council for its ruling..
• Any request for advice or a ruling of the Shariah Advisory Council under this Act or any other law shall be submitted to the secretariat [of the SAC].

57. Effect of Shariah rulings

Any ruling made by the Shariah Advisory Council pursuant to a reference made under this Part shall be binding on […] the court or arbitrator making a reference under section 56.

58. Shariah Advisory Council ruling prevails

Where the ruling given by a Shariah body or committee constituted in Malaysia by an Islamic financial institution is different from the ruling given by the Shariah Advisory Council, the ruling of the Shariah Advisory Council shall prevail.

We briefly examine the decision of the Federal Court, and compare the reference procedures under the Act and the Asian International Arbitration Centre's ("AIAC") i-Arbitration Rules 2018 ("i-Arbitration Rules"). As these provisions apply to arbitrators as well, we consider some of the issues which arise therefrom.

Purpose of the SAC in disputes involving Islamic financial business

The Federal Court took the view that cooperation and integration between civil courts and the SAC was necessary for the smooth functioning of Islamic financial banking and Islamic financial services in Malaysia. This meant that the SAC's role in disputes over Islamic transactions is to ensure consistency and certainty in the application of Islamic principles. To this end, Sections 56 to 58 ensure that civil courts and arbitrators do not rely on various different sources and interpretations of Islamic principles (as they did in the past), but to instead refer to a single authority to ascertain the applicable Islamic principles.

Limitation on the right to lead expert evidence

According to the Federal Court, parties are not entitled to lead expert evidence on questions concerning Islamic law for Islamic financial business, because "[t]he civil courts are not in a position to appreciate and determine the divergences of opinions among the experts [on Shariah] and to decide based on Shariah principles". The Federal Court considered that allowing party-led expert evidence would be unhelpful to a civil court judge, as it would push a judge to (i) make a decision on what source of Islamic law he or she would refer to, (ii) which mazhab (school of thought) should be adopted in the face of differing opinions, and (iii) whether civil law or Shariah law should be the applicable law; decisions which – according to the Federal Court – a civil court judge is not in a position to make.

Effect of an SAC ruling

Helpfully, the Federal Court affirmed that the SAC's ruling does not conclude or settle the dispute between the parties, but is limited only to 'ascertaining' the position of Islamic law applicable to the dispute. The SAC does not finally dispose of the dispute between the parties. It does not engage in the judicial process of determining the rights of the parties. This is consistent with the Central Bank of Malaysia's ("BNM") internal Manual for References to Shariah Advisory Council by the Civil Court and Arbitrator (available in Malay only) ("Manual"), which provides that:

"[in] answering the questions referred by the court or arbitrator, the Shariah Advisory Council is aware that its role is merely to ascertain the "hukum Syarak" (Islamic Law) in relation to the issues where reference is made. The Shariah Advisory Council does not have any jurisdiction to make any finding of facts or to apply a particular "hokum" (principle) to the facts of the case or to make a decision. Whether in relation to an issue or for the case since such jurisdiction is vested with the court or arbitrator."

Reference to Shariah Advisory Council for arbitrators under the Manual

The Manual builds on the procedural framework provided in Section 56 of the Act.

Before making a reference to the SAC, an arbitrator should first refer to any published rulings of the SAC at BNM's website, or by inquiring with the Secretariat of the SAC. Where there is no published ruling on the matter, the arbitrator shall refer the dispute to the SAC, setting out the parties to the dispute, along with a brief description of the relevant facts, copies of relevant documents, and the question(s) of Shariah to be decided.

According to the Manual, a question of Shariah law on a matter related to Islamic financial business may relate to the business structure of the parties, its products or services, and its implementation or operation, terms and conditions, or documentation.

In contrast with the ruling of the Federal Court, the Manual allows a reference to be accompanied by the written opinions of the parties' respective Shariah experts. In fact, the Manual allows the SAC to invite the parties' respective Shariah experts to submit their opinions on the matter referred, if deemed necessary by the SAC.

The Manual also describes the typical reference process as follows:

• The arbitrator refers a point of Shariah to the SAC through the SAC's secretariat. Within 7 days from the receipt of the reference, the Secretariat shall inform the members of the SAC in writing to propose a meeting. The Secretariat shall arrange for a meeting at a time and place agreed by the SAC to discuss the arbitrator's reference on a point of Shariah.
• The secretariat then conducts preliminary research and analysis on the point of Shariah. The outcome of the research and analysis would be presented to the SAC during its meeting for a decision by the SAC. The secretariat records the decision of the SAC.
• Once confirmed by the Chairperson of the SAC, the secretariat will communicate the SAC's decision to the arbitrator in earnest.

Barring any exceptional circumstances, the SAC's decision shall be issued no later than 90 days from the date the reference (complete with all supporting documents) is received by the Secretariat.

Reference under the Asian International Arbitration Centre's i-Arbitration Rules 2018

We previously reported on the 2012 iteration of the then Kuala Lumpur Regional Centre for Arbitration's i-Arbitration Rules. The Rules have since seen a number of revisions, the latest being in 2018 in conjunction with the centre's rebranding as the AIAC.

Rule 11 of the i-Arbitration Rules provides a reference procedure on questions of Shariah, albeit with a number of salient differences:

• The i-Arbitration Rules are not limited to issues of Shariah arising from an Islamic financial business.
• It is not mandatory for a reference to be made on issues of Shariah under the i-Arbitration Rules.
• Under the i-Arbitration Rules, a reference may be made either to a "Shariah advisory council of accepted Islamic scholars or experts that are qualified to issue religious rulings" ("Shariah Council"), or a "qualified expert in the field of Shariah". Specifically, the reference is to be made to the Shariah Council under whose purview the Shariah aspect to be decided falls, where there is one. Where there is none, the parties can agree on the identity of the Shariah Council or Shariah expert. If the parties fail to agree, the expert would be appointed by the arbitral tribunal.
• The rules are silent on whether the opinion of a party-appointed Shariah expert can be adduced.
• If a reference to the relevant Shariah Council or Shariah expert has been made, the arbitral tribunal must then adjourn the arbitration proceedings until a ruling has been given. However, if there are any other areas of dispute which are independent of the ruling, the arbitrator must instead proceed on the issues. By contrast, the Manual and the Act are silent on this.
• The Shariah Council or Shariah expert must deliver its ruling within 60 days from the date the reference is made, instead of 90 days under the Manual. If no ruling is delivered within this time period, the arbitrator may proceed to determine the dispute and give its award based on the submissions it has before it.
• The i-Arbitration Rules are silent on the Shariah Council or Shariah expert's internal decision-making procedure.
• Unlike the Act, the costs of i-Arbitration expressly includes the expenses reasonably incurred by the arbitral tribunal in connection with any reference to a Shariah Council or Shariah expert.

Comment

The Federal Court's decision is likely to reflect the position of a similar reference procedure for any Islamic capital market business or transaction under Malaysia's Capital Markets and Services Act 2007. In light of the applicability of Sections 56 to 58 of the Act to arbitrators, the Federal Court's decision raises a number of uncertainties which are relevant to arbitrations related to Islamic finance and capital markets in Malaysia:

• Both the Act and the i-Arbitration Rules rely on an arbitrator recognising whether a Shariah issue exists in a particular dispute, and properly referring issues of Shariah for ascertainment. It is unclear whether the validity of an award would be affected by the inadvertent omission or deliberate refusal by an arbitrator to make a reference.
• Neither the Manual nor the Act makes any provision in the event the SAC does not provide a timely decision on the matter referred. On the other hand, although Rule 11(7) of the i-Arbitration Rules stipulate that "the validity of an award given […] shall not be affected in any way by the unavailability of the relevant Council or Shariah expert's ruling", this may invite potential challenges to the validity or enforcement of an award for failing to address all issues submitted to a tribunal for resolution (for our review of challenges to awards made infra petita, see here).
• The Act does not distinguish between domestic and international arbitrations. Given the broad definition of 'Islamic financial business', it is unclear whether the applicability of the Act's reference procedure is a matter of substance (i.e. governed by the applicable law chosen by the parties to govern the Islamic financial transaction) or procedure (i.e. governed by the procedural laws of the seat of the arbitration).
• It is also uncertain whether the Act's reference procedure would operate as a mandatory rule. Generally, mandatory rules are a genus of rules of a country which applies regardless of the parties' choice of law. Thus, by virtue of a transaction's relationship with Malaysia, parties may find themselves unable to opt out of the Act's reference procedure simply by choosing a different applicable law and/or seat of the arbitration.

It remains to be seen how foreign investors would react to the notion of a regulatory body – that governs Malaysian Islamic financial institutions and certifies their Islamic products – making decisions on those same entities' compliance with Shariah law. Time will tell whether the principle of party autonomy in arbitration is sufficient to exclude compulsory reference to the SAC for Islamic transactions related to Malaysia.

The full text of the Federal Court's judgment is available here. The i-Arbitration Rules are available here.

[1]        JRI Resources Sdn Bhd v Kuwait Finance House (M) Bhd (President of Association of Islamic Banking Institutions Malaysia & Anor, interveners) [2019] 3 MLJ 561

For further information, please contact Peter Godwin, Regional Head of Practice – Dispute Resolution, Asia and Managing Partner, Kuala Lumpur, Daniel Chua, Associate, or your usual Herbert Smith Freehills contact.

Disclaimer

Herbert Smith Freehills LLP is licensed to operate as a Qualified Foreign Law Firm in Malaysia. Where advice on Malaysian law is required, we will refer the matter to and work with licensed Malaysian law practices where necessary.