Exploring Islamic agency

IFR Middle East Report 2011
11 min read
EMEA

Wakala is frequently used on financing transactions. By Andrew Hart, partner, Alex Childs, associate, and Vanessa Ross, trainee, in the energy practice at Fulbright & Jaworski International LLP in London.

The term wakala is used in Islamic finance to describe a contract of agency or delegated authority pursuant to which the principal (muwakkil) appoints an agent (wakeel) to carry out a specific task on its behalf. The wakala concept is used frequently in financing transactions, including sale and purchase (where the agent can buy or sell assets on behalf of the principal that appointed it), borrowing and lending of funds and assignment of debt, guarantees and pledges. In this article, the authors explain the use of wakala in Islamic finance, summarise the key features of the relationship between the agent and the principal and provide a recent example of a wakala on which they have worked.

Background

Financial institutions have adopted various Sharia-compliant means of advancing funds to their customers for the purposes of generating income. These are termed modes of finance and are more fully described below:

* Participatory mode – This mode involves the financial institution making a direct equity investment in the underlying business and sharing in the profits (or losses) of that business. Mudarabah, a partnership arrangement whereby one partner provides capital for investing in a commercial enterprise while the management and work is exclusive undertaken by another partner, is an example of a participatory mode of finance.

* Non-participatory mode – Here, the financial institution does not make a direct equity investment in the enterprise but instead provides financing for a specific purpose. An example of this is a murabaha, which consists of a financial institution purchasing an asset (mal) and selling it to the customer, who will make one or more deferred payments over time to cover the payment for the asset plus the mark-up, which is the profit element for the financial institution.

* Accessory mode – The final Islamic mode of finance involves the financial institution taking on some sort of role acting on behalf of the customer, for example, as agent (wakeel), trustee (amin) or guarantor (kafil). Accessory modes can be used in isolation or as part of a larger transaction involving, for example, a murabaha or other form of participatory or non-participatory structure. This article will focus on the accessory mode of wakala.

Typical wakala structure

The structure of a typical wakala arrangement is set out below:

Diagram

* The principal appoints the agent by entering into a wakala. This agreement will document the terms of the agent’s appointment and the fees it will receive for carrying out its work, together with a list of its duties.

* Following its appointment, the agent will undertake certain tasks as documented in the wakala as agent on behalf of the principal. These will include investing money received by it from the principal into the business in relation to which the agent has been appointed.

* The agent will be contractually obligated to pass on any profits generated by the business to the principal. It must also perform its obligations according to the instructions of the principal.

Characteristics of wakala

Any transaction employing a wakala structure should comply with the objectives of the Sharia. On that basis, it is essential that the Islamic prohibitions against interest (riba), uncertainty (gharar) and gambling (maysir) are complied with.

In addition, to the extent that the wakala arrangements relate to the purchase of goods, it is important that the transaction adheres to the general principles applicable to sales contracts (bai’) and that the sales contract does not relate to any forbidden (haram) object (for example, alcohol, pork or impermissible financial instruments). The appointment of an agent for acts including fasting, prayer and giving evidence are also prohibited as these should be carried out by the principal.

More specifically, certain rules and characteristics applicable to wakala are set out below:

* Appointment of agent – The appointment of an agent by the principal constitutes offer and acceptance. The role of the agent should be clearly set out in the wakala and may either be specific (for example, the agent is to sell a particular asset at a given price or as per specific instructions of the principal) or general (for example, a principal may appoint an agent to purchase certain kinds of good as and when required by it).

* Subject matter – The subject matter of the wakala should be clearly defined so as to avoid any ambiguity and should not contravene Sharia principles. In the case of an asset (mal), for example, the type, quality and other characteristics of the asset should be documented. The wakala cannot relate to any goods that are prohibited under the Sharia, such as alcohol. Conflicts of interest must also be avoided with the result that any agent cannot sell his own property to the principal without fully disclosing that it belongs to him.

* Remuneration – The agent is typically reimbursed for any expenses incurred by it on behalf of its principal. In instances where the agency relates to the sale and purchase of goods, the question as to whether an agency fee is to be paid would usually depend upon whether the agent is the financial institution or the customer. To the extent that the customer instructs the financial institution as agent, the financial institution would most likely charge the customer for the agency services rendered by it. However, where the customer is instructed as agent by the financial institution, this typically occurs as part of a larger transaction, and as such the customer would not normally be paid an agency fee.

* Exercise of agent’s duties – The agent must act in good faith and use reasonable care and skill when exercising its functions. It must perform its duties in accordance with the terms of the wakala agreement and cannot entrust such duties to another without first obtaining the prior consent of the principal. An act exercised by the agent will be deemed to be carried out by the principal. There has been some debate as to whether this applies in instances where the agent acts ultra vires, however, the consensus seems to be that such acts would be valid subject to ratification by the principal.

Use of wakala

The concept of wakala is widely used in Islamic banking transactions in respect of all modes of finance. The role of agent can be undertaken by either a financial institution (as agent of the customer), or by the customer (as agent of the financial institution) as part of a larger transaction. The reasons for the use of an agent vary widely, but include the inability or unwillingness of the principal to act personally. Geographical location may also be a reason. If, for example, the principal is not located in the jurisdiction of incorporation of the customer, it may be easier to appoint an agent to exercise certain functions.

In syndicated lending on Islamic facilities, one bank will typically act as the point of contact between the borrower and the group of lenders. This is frequently structured as an agency relationship. In such financings, it is also common for the onshore security agent to hold the security as wakeel, for and on behalf of the lenders.

However, to the extent that the concept of a trust is recognised under applicable law, it may be preferable for the wakeel to hold the security as trustee (amin) and not as agent. This is because, upon an insolvency of the wakeel that holds the security on trust, the secured property would be insulated and held for the benefit of the lenders, whereas if the wakeel held the security as agent, such property might fall into the general asset pool of the wakeel.

Recent case law

The High Court decision in Investment Dar Co KSCC v Blom Developments Bank Sal (2009) raised a number of interesting issues. However, it should not be seen as undermining the integrity of wakala agreements.

* Background – In 2007, Blom Developments Bank (Blom) placed US$11.7m (the capital sum) with The Investment Dar Company (TID) in two transactions performed under a Master Wakala Agreement (the agreement), which was governed by English law. The Agreement provided that TID would invest the capital sum in a Sharia-compliant manner. At the end of the agreed investment period for each transaction, TID was contractually obliged to pay Blom the capital sum plus an agreed return of 5% on any profit made (the anticipated profit).

At the end of 2008, it became clear that TID would be unable to pay Blom the capital sum and the anticipated profit at the end of the investment period. In January 2009, Blom applied for and was granted summary judgment for the capital sum but not the anticipated profit. TID appealed on the grounds that the agreement did not comply with Sharia principles and it was therefore ultra vires on TID, as the anticipated profit amounted to a payment of interest (riba) which is prohibited (haram) under Sharia law. The appeal was allowed on the basis that there were issues that required full consideration at trial.

* Implications of the decision – The decision did not provide that the Agreement was invalid or non-Sharia-compliant, rather that TID had raised sufficient issues for a trial to be necessary.

The judgment also made clear that even if the agreement was held to be ultra vires, Blom would still have a claim of restitution against TID. To put the parties back to their pre-contractual positions, TID would remain liable for the capital sum.

To the extent the agreement was found to be intra vires, the contract claim would be successful and TID would be liable to pay the capital sum plus the anticipated profit. As the only difference between these two outcomes was whether TID was liable for the anticipated profit, the appeal was allowed on the condition that TID pay the capital sum to Blom.

It should be noted that the Court did not make a decision on the merits of TID’s defence that the agreement was not Sharia-compliant, merely that such a defence could be argued in theory.