By Esther Agbaje
Bankruptcy is a potential outcome most people do not like to discuss. This may be why Islamic finance regulators give limited attention to dissolving, discharging, or repaying debt in a manner that meets Islamic principles. Instead, Islamic finance regulations place significant emphasis on the creation of financial products and on conducting transactions in a morally conscientious way. Countries like the UAE and Malaysia are leading the charge in developing comprehensive Islamic financial systems with clearer rules and guidelines about financial products compatible with the tenants of Islam. Is either country doing the same when it comes to failed financial ventures that end in bankruptcy? In this post, I look at how both Malaysia and the UAE address bankruptcy in their legal codes, and how Islamic principles are not an intentional component of their respective bankruptcy codes.
In the UAE, the Commercial Code (No. 8 of 1984) and the Commercial Transactions Law of 1993 govern bankruptcy. These laws apply in all of the emirates, but the Dubai International Financial Center has its own laws regulating finance including bankruptcy. According to the UAE law, bankruptcy cases are adjudicated in the civil courts. Judges do not consider Islamic law during the proceedings despite the fact that Islamic law is the “main source of legislation in the UAE.” Bankruptcy is considered wholly secular even in disputes concerning Islamic financial products. The laws discussing bankruptcy in the UAE are influenced and in some ways mimic European bankruptcy laws, and proponents of additional reforms want to continue that trend. The system around bankruptcy developed and could stay this way because bankruptcy laws similar to conventional laws could reassure foreign investors in the UAE and make the system more accessible to them.
Similar to the UAE, Malaysia has two laws that regulate bankruptcy – Bankruptcy Law of 1967 and the Malaysia Companies Act of 1965, and bankruptcy is adjudicated in the civil courts. While Malaysia has a centralized Islamic financial system, as codified by the Islamic Banking Act of 1983, this law does not directly address bankruptcy. Instead, the Companies Act, which looks similar to UK and Australian laws, governs how debtors and creditors are treated in a bankruptcy proceeding. Despite Malaysia’s progress on developing a centralized standard for Islamic finance, bankruptcy law is outside of the Islamic context and could potentially conflict with the standards developed. Malaysia, like the UAE, also seeks foreign investors and processing bankruptcy outside of the Islamic financial context could be a signal to these investors that if something goes wrong they can still recoup their losses using a familiar conventional system.
In both countries bankruptcy procedures are not clearly addressed by Islamic law, and other Muslim majority countries fail to address the issue as well. Haider Ala Hamoudi offers reasons why bankruptcy is left out of Islamic financial regulations. One theory he posits is that Islamic finance overall essentially mimics conventional finance and only allows for certain accommodations to the faith. Islamic finance now crosses borders and in order for Islamic bankers to make their products attractive, the underlying system has to be one that matches with conventional finance, but with an Islamic veneer. Because of this, Islamic regulators do not prioritize regulating Islamic bankruptcy because the emphasis on repaying debts and disallowing discharge of debts would not be an attractive to Muslims or large corporations who may be more interested in restructuring and debt discharge systems in the US or Europe.
Another reason he thinks there is a lack of interest in creating an Islamic bankruptcy law is because the rules in classical Islam concerning insolvency are not relevant to a modern commercial society. The rules that he considers “medieval” include the use of debtor’s prisons until the debtor is able to pay, the burden of proof on the debtor to prove that he lacks the assets to pay, treating debtors as incapacitated until they can pay, and finally the lack of discharge to the bankrupt. He briefly discusses how Islamic scholars are hesitant to interpret sharī‘a in a way that addresses modern problems, which could lead to changes, and that modern life application of Islamic law continues to be a source of debate.
I disagree with Hamoudi that the idea of developing Islamic law standards for bankruptcy is ill suited for the modern world. The principles concerning debt repayment and forgiveness in classical Islam can be a foundation for a bankruptcy code that incentivizes debtors to pay debts while also institutionalizing forgiveness from creditors. For example in Malaysia, in a debt collection case, the Malaysian High Court, though a civil court, decides in a way that give some leniency to debtors, which is a principle found in the Qur’ān. In Ropli Ishak v. Hong Leong Leasing SDN BHD, the question at issue was if the estimate of the debt in the creditor’s petition needed to be a true account or if an estimate was satisfactory. The court held that as long as the estimate was not a “sham” then it would be sufficient, even if the debtor thought that it was a flawed estimate. Though the court ruled that a debtor could not challenge the estimate in the creditor’s petition, it also ruled that this estimate capped what the creditor could receive from the debtor. “The correctness of the estimate given by a petitioning creditor in his petition cannot be questioned by the debtor…when it comes to proving the debt, the petitioning creditor would be bound by his estimate and cannot take any benefit in the administration in bankruptcy except on the basis of his estimate.” Even in civil courts concepts of leniency to the debtor exists in practice. Malaysia could include more of these principles either in their two codes or create an Islamic Bankruptcy Code that has jurisdiction over Islamic financial products only.
Neither the UAE nor Malaysia has a bankruptcy law that strictly adheres to classical Islamic law, but rather these two countries enacted laws that match conventional bankruptcy laws. This is not to say that conventional codes are per se wrong, but they have a different emphasis on the repayment of debt. As Ibrahim Warde noted, “Islam recommends forbearance and even loan forgiveness to borrowers in difficulty (Koran 2:280-1). In a secular system such prescriptions can be ignored, but in a religious or hybrid system they cannot.”
There is an opportunity for Islamic finance to develop an innovative bankruptcy code that attracts religious adherents and provides security for creditors. The UAE and Malaysia as leaders in the Islamic finance sector should begin to use resources like Sharī‘a Advisory Councils and sharī‘a judges to develop legislation, regulation, or judgments to explicitly include sharī‘a principles. More sections of the code would “take cognizance of shariah as a matter of substantive and procedural law,” which is not happening now. For instance in Malaysia, the Central Bank recommends instituting a sharī‘a commercial court dedicated to Islamic banking legal matters. This recommendation and others, which will be discussed in a future post, could provide for more intentional discussion on developing a bankruptcy system that properly incorporates Islamic principles.
 Haider Ala Hamoudi, The Surprising Irrelevance of Islamic Bankruptcy, 19 Am. Bankr. Inst. L. Rev. 505, 505 (2011).
 Ibrahim Warde, The Relevance of Contemporary Islamic Finance, 2 Berk. J. Middle E. & Islamic L. 159, 169 (2009).
 UAE Commercial Code (No. 8/1984), https://lexemiratidotnet.files.wordpress.com/2011/07/federal-law-no-8-of-1984.pdf.
 UAE Commercial Transactions Law (No. 18/1993), https://lexemiratidotnet.files.wordpress.com/2011/07/federal-law-no-18-1993.pdf.
 Elias Moubarak, Islamic Finance and Markets: Getting the Deal Through, Trowers and Hamlins (Sept. 23, 2014), https://gettingthedealthrough-com.ezp-prod1.hul.harvard.edu/area/58/jurisdiction/33/islamic-finance-markets-united-arab-emirates/.
 UAE Commercial Transactions Law, supra note 4, at Section 653(1).
 United Arab Emirates Constitution, https://www.constituteproject.org/constitution/United_Arab_Emirates_2009?lang=en.
 Sarosh Zaiwalla, UAE Insolvency Law: Priority for business growth, Emirates 24/7 Business (Jan. 25, 2015), http://www.emirates247.com/business/uae-insolvency-law-priority-for-business-growth-2015-01-25-1.577945.
 Hamoudi, supra note 1, at 510-511.
 Malaysia Bankruptcy Act (1967) http://iiiglobal.org/component/jdownloads/finish/204/1251.html; see also Sonali Abeyratne, Corporate Insolvency in Malaysia, INSOL Int. Insolv. Rev. 177, 178 (2000).
 Sherin Kunhibava & Shanthy Racagan, Shariah and Law in Relation Islamic Banking and Finance, 26 Banking and Finance L. Rev. 539, 550 (2011).
 Abeyratne, supra note 10, at 178.
 Kamal Abdelkarim Hassan & Muhamad Kholid, Bankruptcy Resolution and Investor Protection in Sukuk Markets, in Islamic Finance: Instruments and Markets 105 (Bloomsbury Information, Ltd., 2010).
 Hamoudi, supra note 1.
 Id. at 510.
 Id. at 513-14.
 Id. at 511-12.
 Id. at 510 n 35.
 Id. at 511.
 See Esther Agbaje, “Debt and Bankruptcy in Classical Islamic Law.”
 Ropli Ishak v. Hong Leong Leasing SDN BHD  3 Current Law Journal 293, Putrajaya, February 17, 2014.
 Ibrahim Warde, Islamic Finance in the Global Economy 163 (2nd ed. 2010).
 Hassan & Kholid, supra note 14.
 Nik Nozrul Thani, et al., Law and Practice of Islamic Banking and Finance 128-29 (2nd ed. 2010).