Shariah’s Black Box

The use of legal fictions to change the form or the consequence of a transaction without changing its substance is certainly not new to the secular law. Liability is often determined by the form rather than the substance of a transaction.[96] But the fundamental difference between a secular use of a legal fiction to convert a problematical “form” to an acceptable one is that the problem itself and the mechanisms to overcome it can be understood, challenged openly, debated, and ultimately modified by smart lawyers, judges, and legislatures to fit changing circumstances. Moreover, if a secular court rules that a given legal fiction fails its purpose, the participants are free to return to the drafting table and restructure the deal.

The debate within Shariah, however, is in effect closed. Its principles remain divine and unalterable[97] and the application of these principles to changing circumstances are subject only to what the Shariah authorities acting independently of a secular legal and political system determine to be permitted and forbidden. Thus, Shariah informs the Shariah-adherent participants in a finance transaction involving interest that interest is divinely forbidden. The participants are also told it is forbidden because it is evil and causes the destruction of society.[98] Somehow though, interest, wrapped up in a different form where all of the elements of interest exist but for the name, exits the black box of Shariah as permissible and presumably good for society.[99]

Thus, a lawyer involved in a complex SCF transaction responsible for shepherding the participants through the process confronts serious challenges at many different levels. In this effort the diligent lawyer would likely focus on four distinct phases of a SCF transaction: (1) determining if the generic investment or type of transaction is prohibited; (2) developing an alternative (i.e., Shariah-compliant) transactional structure necessary to achieve the financial or commercial goal of the “secular” or Shariah non-compliant investment or transaction; (3) drafting the necessary legal agreements and documents to implement the alternative transaction; and (4) preparing the filing of any regulatory and compliance documents with government agencies.

At each stage of this effort, the lawyer is in effect wrapping the Shariah component of SCF in what appears from the casual observer to be a secular black box. This process begins at the first level when the lawyer turns to the Shariah authorities chosen by the client to determine whether a given investment or transaction is Shariah-compliant. In most cases, the Shariah authority issues a fatwa or legal determination in the form of a terse answer to a fact situation, oftentimes but not always with some rationale. For example, a client may wish to invest in a trucking business that hauls alcoholic beverages along with other commodities. While the consumption of alcohol is generally understood to be forbidden by Shariah, the question arises whether owning a business that transports alcohol which is not owned or specifically destined for a Muslim is also forbidden. Also, is there a percentage threshold of profits from the transportation of the alcohol which is relevant to the determination whether the investment is permitted or proscribed?

At this level, the attorney invariably treats the Shariah jurisprudential analysis as a black box and relies on what his client considers to be a determinative Shariah ruling from someone the client determines to be a Shariah authority.[100] In the case of a client making an investment on its own behalf and not representing that the Shariah ruling is authoritative to any third-party, and assuming there are no grounds for third-party reliance on the authoritativeness of the Shariah ruling, the lawyer’s acquiescence to the black box appears reasonable.[101]

But the professional’s reliance on the black box of Shariah might give rise to serious problems precisely where there is a duty of care relative to the propriety of the ruling and the legitimacy or authoritativeness of the Shariah authority issuing the ruling. The legal exposure for a breach of such a duty, as discussed above in the illustration of the registration statement of the mutual fund, will depend on the kinds of representations made and the ability to insulate the client with disclosures of the risks and with warranty and representational disclaimers.

After an investment or transaction is determined to be forbidden by Shariah, legal counsel must address the second phase of the transaction. Here the attorney must be certain that the client properly explains to the Shariah authority what the investment or transaction involves in its secular or Shariah non-compliant structure and ask the Shariah authority to suggest a structure. SCF as it has developed to date includes a range of legal structures generally acceptable in Shariah commercial transactions to bring otherwise forbidden investments into Shariah compliance. Most of these transactional structures are meant to avoid the prohibition against interest.[102]

Once the Shariah authority solves the Shariah compliance problem by suggesting an alternative structure to “rid” the transaction of the offending elements, be it interest or uncertainty, the client’s legal counsel must now determine if the new structure changes the substance of the deal or merely camouflages the problem identified by Shariah through a change in the form of the deal. This analysis is fundamental in many areas, including disclosure, compliance, taxation, and notably assessing enforceability in the event of default.[103]

After having fully assessed the requirements of the Shariah-sanctioned deal structure, legal counsel begins the third phase by drafting the “secular” contracts and various other agreements to fit the demands of Shariah to conventional legal and regulatory frameworks. This process can require the drafting of certain collateral agreements which in themselves contradict the principal agreements and transactional documents and potentially violate Shariah precepts. One such example occurs when an SCF transaction is structured as a joint-venture leasing arrangement. While the intent of the parties as reflected in all of the transactional documents is to create a joint-venture leasing arrangement precisely because they do not wish to run afoul of the prohibition against interest, the parties still desire to allocate the tax burdens and benefits as if the transaction were a straightforward financing with interest.[104]