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Industry Updates

Drafting Shariah Compliant Memorandum and Articles of Association for a British Virgin Islands Company

03 May 2012

This article was first published in Islamic Finance News in May 2012.

Philip Ireland highlights the issues and pitfalls to be addressed in drafting the memorandum and articles of association of a company incorporated under the BVI Business Companies Act, 2004 which is intended to be Shariah compliant.

Although legal firm Maples and Calder (Maples) does not advise on Shariah law, having an office in Dubai where we have incorporated many British Virgin Islands (BVI) companies which are intended to be Shariah compliant, we are quite familiar with the issues and pitfalls to be addressed in drafting the memorandum and articles of association (M&As) of a company incorporated under the BVI Business Companies Act, 2004 (the Act) which is intended to be Shariah compliant.

Following the order of the standard incorporation M&As that Maples typically uses for a conventional company incorporated under the Act, the specific issues to be considered are as follows:

1. General objects and powers

1.1 The proposed investments of a Shariah compliant company must be Halal in order for them to meet the requirements of Shariah. A company will be prohibited from investing in certain industries, including:

(a) The production or distribution of alcoholic beverages;

(b) The production of pork products;

(c) The production or distribution of certain types of entertainment, including pornography;

(d) Any business that earns income from gambling (including online); and

(e) The production or sale of military equipment and weaponry.

1.2 Shariah does allow flexibility to invest in companies which derive a small portion of their income from prohibited sources (generally agreed not to exceed 5%). This flexibility recognizes that strict adherence is sometimes not possible; including for example where an investee company derives income from a prohibited source after the company has made its investment. In such cases, the company may "purify" these earnings by separating them from the company's Shariah compliant assets, and disposing of them in a manner approved by its Shariah board or scholar (for example, by donating them to a charity).

1.3 In drafting the general objects and powers of a Shariah compliant company, consideration must therefore be given to these principles. Although it is not strictly required to include these prohibitions, it is imperative that the company does not have the express authority to undertake such activities (and indeed that it does not undertake such activities).

2. Share classes

2.1 Of fundamental importance is the fact that for a Shariah compliant company, all investors must be treated equally in accordance with the principles of Shariah law, so there should only be only one class of shares issued to investors. It is possible to have a separate class of management or voting shares, provided these are not issued to investors.

2.2 If shares are attributed with a par value, then often these shares will be denominated in a GCC currency (which clearly poses no issues from a BVI perspective).

3. Forfeiture

If forfeiture provisions are included (following non-payment of a call on shares), then care must be taken to ensure that no interest accrues on any late payment. Interest, per se, cannot be charged or received according to Shariah law and all references to interest payments (whether in the forfeiture provisions or otherwise) must be stripped out of the M&As.

4. Appointment of a Shariah committee

4.1 The main structural difference from a conventional company is that a Shariah compliant company will need to appoint a Shariah board or Shariah committee (in addition to the board of directors) composed of Islamic scholars (or sometimes a single Shariah scholar) to review the company's proposed investments and its business operations to determine whether they will be Shariah compliant and issue an appropriate Fatwa (opinion) that this is the case.

4.2 Different scholars may have different views on what is and is not permissible; it is therefore important that the scholars are engaged early in the establishment process.

4.3 In light of this, the article in the M&As that provides for delegation by the board of directors should specifically reference the establishment of a Shariah committee and the delegation of all Shariah considerations to such committee. There are no specific requirements with respect to the composition of such a committee or the manner in which it is to conduct business. Such a committee can therefore be established in the same way as any other committee of the board of directors.

5. Proceedings of directors

To entrench the concept of Shariah compliance, it is advisable to include a specific provision in the articles setting out how the directors are to conduct the business of the company to the effect that the directors shall at all times operate the company in accordance with the principles of Shariah. Accordingly only persons who are familiar with the basic principles of Shariah law should be appointed as directors of a Shariah compliant company.

6. Specific Shariah article

6.1 Although clearly the M&As of a company incorporated under the Act will be governed by the laws of the BVI (and therefore they cannot be stated to be subject to Shariah law, per se), it is worth considering the inclusion of a specific article at the end of the M&As to reiterate the fact that the directors shall endeavor to operate the company in accordance with the principles of Shariah and that in the event of a dispute in relation to the interpretation of Shariah, questions of interpretation shall be referred to the Shariah committee.

6.2 In addition, a further article could be added to provide that if the directors fail to appoint an expert in Shariah within a certain number of days of a dispute arising and being requested to do so by any director, an expert may be appointed by the shareholder holding the greatest number of shares in the company.

7. Other considerations

7.1 Shariah places certain financing limitations upon a company, including prohibiting the following activities:

(a) Providing or obtaining conventional interest-bearing loans, including for purposes of leveraging / gearing a fund’s portfolio investments;

(b) Investing in overly-leveraged underlying portfolio companies;

(c) Investing in interest-bearing financial instruments, including convertible securities;

(d) Investing cash in short-term financial instruments or derivative transactions that are based on underlying assets or obligations that are not Shariah compliant; and

(e) Engaging in naked short-selling and other derivative transactions where the company does not have title to the asset being sold. If a company intends to use any of these financial strategies, it is not likely to be compatible with Shariah.

7.2 If a company intends to use leverage as part of its investment strategy, it should also consider whether Shariah compliant financing will be easy to obtain, given the nature and geographic location of the company’s target investments.

While Shariah compliant financing is widely available in the Middle East and certain parts of Asia, this isn’t yet the case in many other parts of the world.

Although the Islamic finance industry has made significant gains, in countries where Shariah compliant financing is not widely available, it will likely cost more than conventional financing.