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The Commercial Division of the High Court in Uganda has ruled that the Islamic banking system is governed by other laws of Uganda such as the Mortgage Act in addition to Sharia law (Islam’s legal system).
Justice Anna Mugenyi, made the verdict in a case in which Kasese Hospital proprietor, John Henry Baguma, challenged the sale of his hospital by Microfinance Support Centre limited (MSC) over an unpaid loan facility of sh303 million plus a 10% mark-up per annum.
Baguma argued that being an Islamic banking transaction, the hospital was supposed to share the profits and losses with MSC.
However, Justice Mugenyi said MSC legally sold the property as collateral under the Mortgage Act because Kasese Hospital was in breach of the contractual obligations.
The judge said it was immaterial whether the business made profits or losses, adding that Kasese Hospital was bound to pay back to MSC the cost of the machinery (sh303mi) plus the mark-up cost of 10% per annum because it was a debt-based facility.
Experts weigh in
Commenting on the court’s judgment, Dr Sulaiman Lujja, the head of Islamic banking and finance department at Islamic University in Uganda, implored those with interest in Islamic banking system to make use of Sharia law experts in drafting the agreements to avoid losing their property.
He noted that the way the agreement was drafted required the hospital to pay back the money even when it made a loss.
“This decision implies that there is limited knowledge of Islamic commercial law (Fiqh muamalat) among the lawyers and judges,” said Lujja.
“Lawyers draft the Islamic banking agreements and argue cases while judges adjudicate Islamic banking cases when they have limited knowledge to interpret sophisticated Sharia doctrines which even Sharia jurists (Ulamas) take years to comprehend and this is going to affect the implementation of Islamic banking as people will fail to distinguish it with conventional banking system.”
Citing Quran chapter 2 verse 283, Lujja said Sharia law allows selling of the collateral. The mark-up should be computed and a lumpsum figure disclosed to the customer instead of percentage per annum like the case of conventional banking where the interest amount would fluctuate with the Central Bank rate (CBR) and inflation.
Because Islamic banking industry is dispute-driven due to unregulated or unstandardized Sharia governance system, which includes Sharia compliance and Sharia advisory boards, Lujja said there is need to develop alternative dispute resolution (ADR) mechanisms for the Islamic banking sector such as arbitration whereby experts can handle the cases.
He said courts need to observe the Islamic rulings (fatwas), decisions, and guidelines of the Sharia advisory board and refer to them in adjudication of Islamic banking-related disputes.
According to him, MSC needs to have a higher authority that regulates its operations, especially Islamic finance operations, to ensure that its operations comply with Sharia principles.
Lujja added that there is a need for a National Sharia Advisory Council to act as a reference to courts and arbitration in resolving disputes.
“In the present case, the judge needed to refer to a reliable body/authority in Sharia but not on the interpretation of lawyers. The asset purchased in Murabaha facility should be made security for financing. In addition, customers should be required to provide additional collateral to cushion the bank side in order to avoid systemic risks.”
Lujja said the government, Bank of Uganda and financial institutions need to include Islamic banking in their financial literacy programmes to address the misconceptions about Islamic finance.
Sophia Kigozi, a partner at Mesa Advocates, argued that Wednesday’s decision by court highlights the regulatory bottlenecks that still exist in achieving an optimum operationalization of the Islamic economy and furthering a clear and conducive environment for Islamic financial business to thrive.
She said the judgment also raises pertinent concerns about the evolution of Sharia law into a predominantly conventional law landscape and its impact on the administration of Islamic financial business.
Kigozi argued that in the absence of an amendment to the Mortgage Act to provide for Sharia-compliant mortgage procedures, it should have been construed clearly in the agreement that Ugandan law will apply to these processes and not have both laws stated as applying concurrently.
Genesis of the case
Around 2017, Kasese Hospital identified a medical equipment for purchase from Biologicals (U) Limited at sh303m and applied it to Microfinance Support Centre limited (MSC) for an Islamic financing facility (Murabaha Financing).
Murabaha Financing necessitated that MSC purchases the medical equipment from the supplier and then sell the same to Kasese Hospital at cost (purchase price) plus mark-up.
On March 31, 2017, the two parties reduced the agreement in writing, providing the conditions and covenants.
The facility that was offered to Kasese Hospital is a debt-based financing category that creates a payback obligation on the customer (whether it makes profits or losses) but not an equity-based financing category that creates a partnership between the financier and the customer in order to share profits and losses of customer’s business.
One of the terms of the offer letter under Clause 4, was that the facility would be available for three years (36 months) from the date of disbursement and that Kasese Hospital would reimburse MSC the cost of purchasing the equipment plus a mark-up of 10% per annum.
The term mark-up was defined in the offer letter as the surplus or profit that Kasese Hospital agreed to pay to MSC over and above the total cost price of the purchased equipment. It was also agreed under Clause 6 of the offer letter that the hospital would provide collateral for a legal mortgage of sh303m.
Due to challenges, Kasese Hospital defaulted in repayment of the cost of the machinery plus the mark-up, contrary to the facility agreement.
Consequently, MSC released the mortgage property under the Mortgage Act by issuing notices of default and subsequent notice of sale to Kasese Hospital.
Upon ignoring the payments, MSC instructed its agents to advertise the mortgaged property and subsequently sold it as per the Mortgage Act.
Kasese Hospital thus filed the suit for a declaration that the Murabaha Facility agreement was governed by Sharia law and the two parties had to share the loss.
