Islamic finance replaces interest with trade, leasing, and partnership. Instead of lending money at a rate, a financier buys an asset and resells it at a markup, leases it, or shares in the profit and loss of a venture. For companies and investors who want Sharia-compliant capital, and for U.S. businesses dealing with counterparties in the Gulf and Southeast Asia, these structures have to work under two systems at once: the religious principles a Sharia board applies and the commercial, tax, and insolvency law of the place where the deal is enforced. Our role is the second part. We do not issue Sharia rulings; we make sure the structure a Sharia board approves is properly documented and enforceable.
The Core Structures
A small set of contracts carries most Islamic finance. Murabaha is a cost-plus sale: the financier buys an asset and sells it to the customer at a disclosed markup payable over time, a structure common in trade and working capital finance. Ijara is a lease, often paired with a promise to transfer ownership at the end, used for equipment and real estate. Musharaka is a partnership in which profits are shared by agreement and losses in proportion to capital, and diminishing musharaka is used in home and project finance. Sukuk are certificates representing ownership interests in underlying assets or a venture, although in practice many sukuk are asset-based and perform much like unsecured debt.
Sharia Principles And Sharia Boards
The structures exist to respect a few core prohibitions: riba, generally understood to include interest; gharar, excessive uncertainty in contract terms; maysir, speculation or gambling; and financing prohibited activities such as alcohol, pork, gambling, and conventional interest-based finance. Compliance is determined by Sharia scholars, usually sitting as a Sharia supervisory board that reviews the documents and issues a pronouncement. Standards published by AAOIFI, the Accounting and Auditing Organization for Islamic Financial Institutions, are widely referenced, and some countries have national authorities, such as Indonesia's National Sharia Council (DSN-MUI) and Malaysia's Shariah Advisory Council. Scholars do not always agree, and a structure accepted in one market may be questioned in another.
Sharia-Compliant Deals Under U.S. Law
In the United States, an Islamic structure is analyzed as what it is under state and federal law, and the characterization has consequences. A murabaha or ijara may be treated as a secured financing under UCC Article 9 and the true lease test in Section 1-203, or as a genuine sale or lease, which affects perfection, tax treatment, and the outcome in bankruptcy. The OCC addressed ijara and murabaha home finance products in interpretive letters in the late 1990s. Real estate structures that require two transfers of title can raise transfer tax and recording issues a conventional mortgage would not. We document these deals so the commercial terms, the security package, and the tax analysis hold up, working alongside the client's Sharia advisors and local counsel abroad.
Disputes Over Islamic Finance Deals
Islamic finance documents usually choose a secular governing law, often English or New York law, and treat Sharia compliance as a matter for the parties and their Sharia board. In Shamil Bank of Bahrain v. Beximco Pharmaceuticals (2004), the English Court of Appeal held that a reference to Sharia principles did not displace English law as the governing law, and later arguments that a transaction was unenforceable for non-compliance have had limited success. Many contracts send disputes to arbitration, with awards enforced under the New York Convention. For a U.S. party, the questions are usually enforceability, characterization, and forum. We handle these matters with our litigation and international arbitration practices.
Practical Points For Companies
Engage the Sharia board early and give it the full documents rather than a term sheet; late objections are expensive. Decide at the outset which law governs, which forum hears disputes, and how the documents will treat a later claim of non-compliance. Model the tax and transfer costs of each structure in every jurisdiction involved. Draft late payment provisions, which typically require charges to be donated to charity rather than retained, and sukuk purchase undertakings with enforceability in mind. And if your U.S. company is taking investment from a Sharia-compliant fund, check whether the fund's screens restrict your business lines or your conventional borrowing, since many funds limit interest-bearing debt relative to assets or market value.
