I. Introduction: three cautionary remarks

In this paper, I shall examine the difficulties raised by interest claims under Sharia law in international arbitration from the perspective of a European practitioner. As a preliminary, however, I would like to make three cautionary remarks.

First, there is no unified body of Sharia law. Rather, there are different schools of Sharia law within each tradition of Islam, notably the Sunnite and the Shiite traditions. 1 Furthermore, there seems to be plurality of opinion within each school, especially in the Shiite tradition, which ignores Ghiyas (analogy) as a source of Sharia law and places more weight on Aghl (reasoning) and Ijtehad (opinion) as dynamic sources of Sharia law.

Second, one should carefully distinguish between national laws that I would call "Sharia compatible" and Sharia law per se. The distinction is important because parties to international contracts sometimes refer to a specific school of Sharia law - as is increasingly done in the banking and finance industry in the Middle East and South East Asia - rather than to a Sharia-compatible national law as the law that should govern their contract. A Sharia-compatible national law remains the law of a specific state as interpreted and applied by the courts and authorities of that state. In contrast, Sharia law per se is interpreted by religious authorities and institutions that often remain independent from the state. [Page211:]

Third, Sharia-compatible finance is one of the fastest growing sectors of international banking. From Beirut and Dubai to Kuala Lumpur, all major banks are engaged in an intensive effort to develop their Sharia finance sector. In some instances, however, "Sharia" is simply a marketing brand for predominantly common law contracts drafted by English lawyers and aimed at attracting Muslim clients. The growing influence of common law in Sharia banking is rather paradoxical, since, historically and structurally, the civil law tradition has been more successful in melding with Sharia concepts and traditions.

II. What is sharia law and how could it become relevant to international arbitration?

International arbitrators can be confronted with Sharia law in three different ways: (1) the law applicable to the dispute is a national law that is Sharia compatible; (2) the parties have expressly chosen Sharia as the governing law of their contract; or (3) the final award may need to be enforced in a Sharia-compatible jurisdiction.

Faced with the growing attraction to Sharia law in various parts of the world, some arbitration institutions, such as the Kuala Lumpur Regional Center for Arbitration (KLRCA), have begun enacting specific rules for Sharia banking and finance arbitrations. 2 Parties can opt into this specific arbitration regime when drafting an arbitration clause or after a dispute has arisen.

Three provisions distinguish the KLRCA Rules for Islamic Banking and Financial Services Arbitration from the general regime that is based on the UNCITRAL arbitration rules and remain applicable to all other international arbitrations. 3 The most significant of these three is Article 33 of the KLRCA Rules, according to which arbitrators should stay the arbitration and refer disputed issues that are governed by - or concern

- Sharia law to a Sharia Council for prior determination. 4 Article 33 thus supports the opinion that Sharia law is more about the exercise of authority by Sharia institutions than the mere application of preestablished rules. [Page212:]

As regards the focus of this paper - a claim for interest under Sharia law

- the answer would seem straightforward and rather uncontroversial: an interest claim would be prohibited by all traditions and schools of Sharia law.

The prohibition of interest, however, is not the end but only the beginning of the story.

Indeed, Sharia law offers a broad range of alternative claims or remedies that could constitute valuable substitutes for a claim for interest. Such alternative claims can take the form of damages for late payment or late performance, claims for sharing or disgorging profits made by the defaulting party, as well as other forms of penalty as provided for by contract or custom. The main requirement, under Sharia, is that such financial damages need to be proven and cannot simply be presumed.

As we shall see below, the prohibition of interest under Sharia law is not incompatible with international arbitration law and/or practice; conversely, the awarding of interest by international arbitral tribunals is not necessarily incompatible with Sharia law.

III. Sharia prohibition of interest and public policy

On the first leg of the question - is the Sharia prohibition of interest incompatible with international law and practice? - one could begin by mentioning recent awards, in particular form ICSID, 5 which have referred to Article 38 of the ILC Articles on State Responsibility (providing for "full recovery of damages" resulting from the breach of an international obligation) as evidence that the payment of interest - and in some instances compound interest - has become an integral part of customary international law.

Can the Sharia prohibition of interest be considered as contrary to customary international law and/or incompatible with international public policy? [Page213:]

The issue was addressed by the Swiss Federal Tribunal in an unpublished decision dismissing an appeal against an ICC arbitral award rendered in Switzerland concerning a dispute governed by Iranian law. 6 The circumstances of the case can be summarized as follows. After the 1979 revolution, Iranian law prohibited interest in compliance with the requirements of Sharia law as enshrined in Articles 43 and 49 of the Iranian Constitution. In 1988, however, the Iranian Guardian Council (or Constitutional Council) rendered an opinion to the effect that Iranian nationals and public entities could, notwithstanding the prohibition of interest and as matter of exception allowed by Sharia principles, claim and receive interest for late payment from foreign parties. Relying on the Guardian Council's opinion, the Iranian party had introduced a claim for interest over damages and late payments before the ICC arbitral tribunal. A distinguished panel of arbitrators dismissed the claim for interest based on the finding that interest had been prohibited after the 1979 revolution and that the exception provided by the Guardian Council in 1988 was discriminatory and thus contrary to international public policy, since it only applied to interest claimed by an Iranian party against a foreign party and not the other way around. 7 The Iranian party moved for a partial annulment of the final award before the Swiss Federal Tribunal, on the grounds that the refusal to award interest notwithstanding the opinion of the Guardian Council amounted to a violation of public policy as provided by Article 190(2)(e) PIL. The Swiss Federal Tribunal dismissed the request for annulment by holding that the right to receive interest is not, per se, a right protected by international public policy:

"As such, the Claimant fails to indicate … why a refusal to award late payment interest would be, per se, in contradiction with the legal order and the relevant system of values [to the public policy exception]. Furthermore, one fails to see how the question of interest would be of relevance to public policy since it is, in particular under Swiss law, a matter over which the parties can freely decide (subject to a few exceptions, such as general restrictions to the freedom of the parties, and specific restrictions destined at the prevention of abuse, in particular abusive rates), and with regard to which a waiver is admissible. Public policy does therefore not require in any manner - and the Claimant does not demonstrate the contrary - that all claims should bear interest.". 8[Page214:]

Yet, in another unpublished Swiss decision, an Iranian seller was successful in obtaining interest for late payment from a European buyer on the basis of Iranian law and notwithstanding the general prohibition of interest under Sharia law. In that case, the contract that was concluded prior to the Iranian revolution had specifically provided for 10% annual interest for any delay in the payment of the purchase price. In defence, the European company had argued the invalidity of the contractual clause providing for late payment interest under post-revolutionary Iranian law. In reply, the Iranian party invoked the exception provided by the 1988 Opinion of the Guardian Council to the effect that Iranian parties are not barred from claiming interest from their foreign debtors. The European company in turn argued that the exception was discriminatory and thus contrary to international public policy. Before the Court, however, the Iranian claimant successfully argued that the public policy exception has only a "negative" effect and should not preclude the application of foreign law, except when its application leads to concrete and effective discrimination. 9 In the instant case, the concrete result of applying the Guardian Council's opinion was to uphold the validity of a contractual clause providing for the payment of interest which, by and of itself, did not lead to any discriminatory results.

This brings me to the second leg of the question: is an international arbitral award ordering the payment of interest contrary to Sharia law or the public policy of a Sharia-compatible jurisdiction?

In my experience, parties from Sharia-compatible countries rarely hesitate to introduce claims equivalent to "interest" in the form of alternative remedies for the compensation of effective and concrete damages that are perfectly compatible with most schools of Sharia law. When Sharia has an impact on the case (directly as the law applicable to the merits or indirectly as the law of the possible place of the enforcement of the award), it belongs to the counsel for the parties to be creative and to justify their claim for interest under these Sharia-compatible alternative remedies. As stated above, such alternative remedies can consist of proven financial damages resulting from late payment or late performance or claims for sharing or disgorging profits made by the defaulting party, as well as various other forms of penalty that can be provided by contract or recognized by custom. [Page215:]

This is demonstrated, for instance, by an ICC arbitral award rendered in Switzerland between two Saudi parties, which, notwithstanding the general prohibition of interest or Riba under the applicable Saudi law, awarded the claimant interest for late payment as an alternative remedy and corresponding to the significant rate of inflation in Saudi Arabia during the relevant period. 10

Such alternative Sharia-compatible remedies are also available, for instance, under Swiss law. Article 106 of the Swiss Code of Obligations (CO) provides for compensatory interest that, if proven by claimant, can go well beyond the statutory late payment interest provided by Article 104 CO (intérêt moratoire). Conversely, Article 423 CO allows for the disgorgement or restitution of profits when, for example, the defaulting party has drawn or obtained undue profits from cash or property withheld from the claimant in breach of contractual obligations. In some cases, the amount of restitution can well exceed the simple or even compound interest. The compensation and claims awarded on the basis of Articles 106 or 423 CO remain, in principle, perfectly compatible with Sharia law and enforceable in Sharia-compatible jurisdictions, even if the amounts awarded exceed simple or compound interest.

IV. Conclusion

Notwithstanding the general prohibition of interest under Sharia law, a mildly creative and well-informed party could seek full recovery of its damages under the alternative remedies provided by Sharia law. These damages could go well beyond the simple interest awarded by, for instance, Article 104 of the Swiss Code of Obligations, and the ensuing award should in principle be recognized in all Sharia-compatible jurisdictions. [Page216:]

1
See the contribution by Tarek Fouad A. Riad in this volume: 'The Issue of Interest in Middle East Laws and Islamic Law'.

2
KLRCA Rules for Islamic Banking and Financial Services Arbitration, available at: <http:// www.rcakl.org.my/pdf/Rules%20for%20arbitration%2010.pdf>.

3
These are: -Article 33 which requires reference of the dispute from arbitrators to Sharia "Council" or Expert whenever the dispute raises a Sharia relevant issue ; - Article 39 on applicable law and -Article 18 (3) which provides that deposit and advance on costs shall be maintained on a non-interest bearing bank account.

4
According to Rule 2, the Sharia "Council" is an advisory council established by the Central Bank of Malaysia and the Malaysian Securities Commission.

5
See Siemens A.G. v. Argentine Republic, ICSID case ARB/02/8, Award, 6 February 2007.

6
Swiss Federal Tribunal Decision 4p.267/1996 and 4p.271/1996 of November 3, 1997 in an appeal against an ICC arbitral award.

7
In its appeal before the Swiss Federal Tribunal, the Iranian claimant had argued that the exception provided by the Guardian Council was aimed at creating equality and not discrimination between Iranian and foreign parties in international trade, since the latter continued to claim and receive interest from Iranian counterparts in foreign jurisdictions. This argument was apparently not fully developed before the Arbitral Tribunal.

8
"En effet, le recourant omet d'indiquer … en quoi le refus d'allour des intérêts de retard apparaîtrait, en soi, en opposition avec l'ordre juridique et le système de valeur déterminants. On ne voit pas d'ailleurs pas en quoi la question des intérêts relèverait de l'ordre public, puisqu'il s'agit, en particulier en droit suisse, d'un point au sujet duquel les parties peuvent en principe librement disposer, (sous réserve des restrictions particulières destinées à prévenir les abus, notamment des taux abusifs), et pour lequel une renonciation est possible. L'ordre public n'exige dès lors nullement - et le recourant ne tente pas la démonstration du contraire - que toute créance porte nécessairement intérêts…". Ibid., at p. 9

9
See Homayoon Arfazadeh, Ordre Public et Arbitrage International à l'Epreuve de la Mondialisation (2006) p. 176 et seq.

10
Published in YB Com. Arb., Vol. XXII (1997) at p. 87 et seq. The Arbitral Tribunal awarded 5% annual interest, which by chance corresponds to the statutory interest provided for by Art. 104 of the Swiss Code of Obligations. Ibid., at p. 90.