Shariah’s Black Box

Lawyers skilled in SCF utilize what are called “tax matters agreements”[105] to have the parties decide for themselves that while the deal might look, feel, and smell like a leasing duck, it in fact is a loan turkey for purposes of tax characterizations and allocations.[106] In other words, the “form” of the deal is a joint-venture-leasing arrangement (and Shariah-compliant), but the “substance” of the deal for tax purposes is a loan with interest. While tax matters agreements are not a recent innovation of SCF lawyers, and indeed are often used for tax purposes in off-balance sheet “synthetic lease” transactions, their applicability in SCF transactions is not self-evident.[107] It is one thing for parties to a secular transaction to establish dual and even contradictory characterizations depending on whether the impact of the characterization is on the party’s balance sheet or tax liability. In such dual-purpose transactions, arguably the standards are different between tax accountability and balance sheet accounting and the parties’ primary intent is to achieve off-balance sheet financing without any concern for the specifics of the structure.[108] In other words, the parties are agnostic as to structure and seek only to achieve both tax and financial accounting benefits.

It is quite another matter, however, when the parties are not agnostic regarding the structure of the deal and where their true intent is to avoid the payment of interest and to establish real indices of ownership as required by SCF. In this case, the cognitive dissonance adds enormous peril to an agreement where all of the documents describe a joint-venture-lease agreement and the parties presume to tell the Internal Revenue Service (“IRS”) that what looks to be the case on the surface and what the parties’ actually intended is not in fact the case. While the IRS might continue to apply the economic reality test[109] and wholly ignore the intent as manifested in the Shariah-compliant transaction documents, it is also quite possible that an IRS or tax court ruling would determine that the tax matters agreement is a ruse or “form” attempting to achieve tax allocations and benefits inappropriate for the true “substance” of the deal: a Shariah-compliant joint-venture-lease agreement.[110]

The final step for the transactional lawyer dealing with the intricacies of SCF involves the various filing requirements of government agencies for reporting and compliance matters. The registration statement or prospectus of a mutual fund is but one of many such requirements where the attorney is asked to opine on the adequacy and compliance of such statements. As described above in the case of the Dow Jones Islamic Portfolio Fund, the Shariah black box exposes both client and counsel to a myriad of issues that do not otherwise exist.

The challenges described above for the SCF transactional lawyer and other professionals advising clients on the intricacies of legal compliance are not inconsequential. In agreements and in law, words matter but they are given context by the intent of the parties. The inherent problem of SCF is that the intent of the parties is to comply with Shariah but the intent of Shariah generally and in any particular transaction is typically lost on the secular SCF advisors.[111] The latter, especially the lawyers, are very good at solving problems by re-structuring a transaction through word-smithing, thereby arriving at the same result in different form. But their approach necessarily is to deal only with the trees hindering the client’s path to the goal within the landscape of the transaction itself.

For the typical, secular financial transaction, this is sufficient because there is no dark forest in which to get lost. An obstacle in the path can be safely circumvented because the problem is transparent for what it is and thus all of its ramifications for disclosure and compliance are understood. When the trees, however, grow out of the forest known as Shariah, it is not at all clear to these professionals why they are where they are, what dangers might lurk there, and where the forest might lead. This is so as the examples have suggested because Shariah is not essentially accessible to the secular professionals. As a consequence, the forest is packaged as a black box and effectively ignored. It is no surprise then that there has been very little attention paid by legal professionals in the published literature dealing with the civil liability and criminal exposure issues unique to a financial or business transaction fitted to Shariah.[112]

Some of the professional literature does grudgingly recognize that SCF lacks the certainty, consistency, predictability and transparency necessary to allow the legal and other professionals to treat it as one would any other secular business transaction. But because this literature is typically geared toward those fully committed to SCF, there has been very little in the way of critical analysis of the inherent contradiction or dangers in the effort to apply Shariah precepts, rooted in what one critical observer terms a “Medieval obscurantism,” to Western financial transactions.[113] The potential dangers are exacerbated by the fact that finance and commerce cannot be separated in practice from the law and its institutions built on certainty, consistency, predictability, and transparency. This brings the secular Western legal institutions, understandings, and duties face-to-face with a sectarian normative legal system rooted in a world bound by the dictates of a god as determined by Shariah scholars fully wedded to the purposes of Shariah.[114]

What this analysis suggests by implication is that the first order of business for the legal practitioner advising a client on a SCF transaction is to ask what, if any, legal exposure might the client have by fitting the desired secular financial transaction to a sectarian, political, and legal institutional framework predicated upon Shariah?