TRUSTS AND SHARIA LAW

John Riches and Christian Miceli provide an insight in the application
of Sharia law principles to trusts
(taken from Issue No 20  – July 2002

The purpose of this article is to provide some preliminary observations on the interaction between common law trusts and Sharia Law. It is designed essentially to assist trust practitioners on the general issues that need to be identified in considering whether trusts are an appropriate devolution planning vehicle for assets held by Muslim families.

The authors are neither practising Muslims nor experts in any particular sect of Islam and therefore put forward their general understanding of certain principles of Muslim law as summarised by learned authors with some reserve. The aim of the article is essentially to raise awareness amongst trust practitioners of the issues that may need to be considered.

The basic structure is as follows:-

  1. General Introduction
  2. Overview on sources of Islamic law
  3. Trust structuring issues
  4. Investment policy
  5. Compliance with Sharia principles
  6. Settlor’s capacity
  7. Zakat
  8. Conclusions

1. General Introduction

The concept of a trust under common law is not wholly alien to Muslims. The Islamic waqf system in many ways resembles the trust with the idea of someone gifting to a third party specific property to be held for the benefit of others. Muslims may be able to use a trust to achieve many of the same ends, since the flexibility of the trust allows adherence to Islamic law and the holding of property for the benefit of others, including charities.

Clearly in principle, as the use of a trust enables property to be alienated to a third party, it could be used as a mechanism for either ensuring compliance withSharia principles, or indeed to thwart them. As the whole issue of avoidance of forced heirship is a subject that has been widely commented on, this article does not intend to cover the relative options of trusts as a mechanism for avoiding forced heirship principles derived under Islamic law or under the codes of civil law systems.

2. The sources of Islamic law

Our first assumption is that the Islamic settlor would wish to create a trust which complies with the principles of Islamic law. There are two principles of Islamic law, the Qùran and Sunna with the former being at the heart of Islam and Islamic law. The Qùran for Muslims is the ultimate legislative authority. Sunna, are the words and actions of Prophet Mohammad which, together with the Qùran, form the two main pillars of Islamic jurisprudence.

The Islamic faith is a progressive faith. Since the Qùran was written in the seventh century A.D., there have been great socio-political changes. Well-established methods of interpreting the Qùran cater for such change and have helped to determine modern Islamic jurisprudence. Thus, legislation is derived by analogy with express rulings in the Qùran (Qiyas). More difficult to define is the method of interpretation used where there is no express ruling in the Qùran orSunna (Ijtihad). Here, any Muslim may create a new ruling based on their inner sense of what is the appropriate rule in all the circumstances looking to the Qùranfor guidance by analogy.

However, it should be noted that there are different schools of thought regarding Islamic Jurisprudence. Each school has different sources of jurisprudence that have resulted in a non-uniform jurisprudence, although the key elements of Islamic law, guided by the teachings of the Qùran and Sunnah, are the same throughout the schools. The main schools are those of Shia Islam and SunniIslam, with the latter having the following sub-schools, Hanafi, Shafii, Maliki andHanbali – each of which have varying sources of jurisprudence which together with the teachings of the Qùran provide the sources of Islamic law. One of the fundamental differences from a jurisprudence perspective between Sunni andShia Muslims is that Sunni jurisprudence is based on a literal meaning of theQùran whereas Shia jurisprudence is based on an interpretation of the Qùranwhich goes beyond its literal meaning.

3. Structuring the Trust

Having set out the sources of the basic principles that a Muslim would wish to comply with, it is important to consider the practical implications of such principles in terms of how the trust is actually structured.

In principle there are a number of different ways in which input can be provided into the operation of the trust to achieve the underlying objective. A number of these are set out below. It is important to note that these are not mutually exclusive and can be considered in conjunction with each other.

Protector
The Settlor can appoint an Alim (an Islamic Holy Man) as the Protector of the trust.

Clearly the general idea of any Protector is to vest in a third party who is not a trustee certain positive or negative powers that relate to trust property. In practice where the settlor chooses an Alim as Protector it is important to state clearly that the powers of the Alim are held in a fiduciary capacity.

Alim as Trustee
If a more ‘hands on’ role is required then an alternative is to appoint the Alim as one of the trustees. Where the normal principles of unanimity apply, this should essentially ensure the day-to-day activities of the trusts comply with Sharia Law. However as a matter of practicality where trusts are administered from an offshore jurisdiction this may be inconvenient in practice.

Investment Advisor
A less formal alternative is to provide for the trustees to appoint or consult with an Alim in relation to their investment decisions or the exercise of discretions – this can be effectively confirmed through the medium of a letter of wishes.

An interesting analogy in the world of Islamic Banks is the appointment of aSharia Supervisor Committee. This Committee is made up of Islamic religious scholars who may also be experts in Islamic banking and financial instruments. The Committee’s advice is sought in relation to investment decisions and the choice of financial instruments to ensure compliance with Sharia law.

Letter of Wishes
Whether or not the Settlor appoints an Alim or a Committee he will still want to prepare a letter of wishes requesting that the Trustees observe the requirements of Sharia in administering the Trust (to the extent that they are not in breach of the law of the country in which they operate).

Type of Trust – Discretionary v Fixed Interest
On a narrow view, where a trust is designed to follow Islamic Law, it could be argued that it should take the form of a number of fixed interests for the various relatives of the settlor for whom provision is being made. In practice however experience suggests that obtaining a discretionary trust coupled with a letter of wishes indicating the settlor’s wish that in overall terms the devolution of assets on the settlor’s death follows Sharia principles is not normally viewed as problematic, since the devolution of assets at death is very precisely drawn, although it is important the letter is couched in terms of non-binding guidance.

Revocable v Irrevocable Trust
One important consideration is the issue of whether the trust should in principle be revocable. It is clearly important to bear in mind that where a trust is revocable careful thought will need to be given to the interests of the beneficiaries under the trusts if these could in any circumstances depart from the rules of forced heirship that could apply to the settlor’s estate on death.

In summary it can be seen that there are a variety of ways in which the framework of the trust can be adapted flexibly to ensure appropriate consultation is undertaken by the trustees and full observance paid to appropriate principles of Islamic Law.

4. Investment Policy

It is particularly important that careful attention is paid as to how the trust is to be administered with respect to investment policy. Section 8 sets out some key background principles. In this context, it may be helpful to distinguish between acceptable investments under Sharia Law and any possible entity in which the trust may consider investing.

Particular consideration should be given in drafting the trust deed to the following points:

  • Specifying a list of non-permitted investments, making it clear in particular that the trustees have no power to invest the assets in the trust fund in interest bearing investments or on deposit,
  • A list of permitted investments with the proviso that such investments are not permitted if the industry benefiting from the investment is ‘sinful’ (see Section 8).

Such considerations raise the wider issues of ethical investment -the case law in this area makes it clear that express provision in the trust deed is a relevant factor to be considered-by being explicit about non-permitted investments from the outset, a well drawn trust deed should ensure the scope for criticism of trustees pursuing such an ethical policy is minimised.

5. Obtaining confirmation on compliance with Sharia principles

One possible option open to Muslims is to obtain a prior clearance that basic operation of the trust envisaged and its terms comply with Sharia Law. This may be achieved by obtaining approval from an appropriate doctor of Islamic law confirming the trust is compliant in principle.

6. Ascertaining capacity of settlor

In circumstances where the trust is written in English and English is the governing provision, based on general principles of both common and Islamic law it is important that the settlor fully understands the effect and import of the trust provisions. Where English is not a language with which the settlor is fluent, it may be appropriate to arrange for the terms of the trust and important documents (such as letters of wishes) to be translated into the settlor’s mother tongue to avoid any doubt that the settlor has not fully understood the effect and import of transferring assets to trustees.

7. Zakat

The principle of giving alms is one of the five fundamentals of Islam. In general, a Muslim is obliged to set aside an annual amount equal to 2.5% of his wealth. In circumstances where a settlor establishes a trust in which he retains an interest, he may request an annual distribution of assets to himself, generally during the month of Ramadan in order that he is in a position to make distribution of Zakatto worthy causes. Where this is anticipated, it is sensible to enshrine this as a standing request in an appropriate letter of wishes at the time the trust is created.

8. Notes on Sharia – compliant Investments

The key to identifying whether an investment is Sharia compliant is the type of profit that the Investment generates. Where the investment generates a pre-determined fixed return, then this profit will be regarded as illegitimate (haram) under Sharia Law. The most important example of haram is usury (riba). Usury is strictly forbidden by the Qùran. In western financial institutions the main incidence of riba is the charging of interest on loans. The concept of interest is regarded as inequitable in Islamic law. There are formidable economic reasons for arguing that the very idea of an obligation to pay interest in relation to business activity which is, by its very nature uncertain, is economically unjust. A businessman is forced to pay interest regardless of whether he makes a profit or not. The inflexibility of the interest based system results in bankruptcies, lack of entrepreneurial flair and inflation. For an investment to be legitimate (halal) under Sharia law, there can be no guaranteed return, instead, the investment must carry with it not only the chance to make a profit but also the risk of loss. Any profit made from such investment is regarded as halal and therefore Shariacompliant.

Examples of non-Sharia compliant investments
Loans by Trustees to beneficiaries, apart from interest free loans, would not be permitted, since if interest is charged, the profit element of the investment is considered haram.

  • Loans to third parties on an interest basis as a means of a trust investment. Once again the interest element is haram.
  • Currency options are generally not permitted.

Examples of Sharia friendly investments
Leasing (Ijar) – although often referred to as a leasing agreement by Islamic banking institutions, effectively the most common form of leasing permitted bySharia law is effectively a hire-purchase agreement. Goods are delivered immediately, with the lessee paying for the goods in instalments, the property being transferred to the lessee upon the agreed final instalment (no interest is charged though on any of the instalments).

  • A type of futures contract known as salam whereby a pre-determined price is paid for goods either sold or bought which are to be delivered on a certain date in the future.
  • Unit Trusts – such an investment is favoured by Islamic banks. An investor, in investing in a unit trust invests his capital together with other individuals without any guarantee of a fixed return on that capital. Although the value of each unit may go up it may also go down. It is this element of risk without a guaranteed return which makes any profits made on such an investment halal, and therefore, Sharia compliant.
  • Equities – the investing in stocks and shares directly is Sharia compliant. The profits derived from the investment in shares, dividends and a rise in the value of each share, re both in keeping with Sharia law principles. Dividends are by their very nature not guaranteed, being at the discretion of the company’s board and can fluctuate in value. Likewise, an investor is not guaranteed to make any capital gain on the initial equity investment, since the value of shares may fluctuate up or down. Any profit from shares is therefore, in principle, halal since the investor in making the investment is not guaranteed a fixed or predetermined share of the profits and puts his equity at risk.
  • A form of business financing known as mudarabah which is almost identical to common forms of venture capital financing. Here equity is provided to a business in return for a share of the profits which the business will generate, such share being determined between the parties. Once again, the investor is putting his capital at risk and is not guaranteed a fixed or pre-determined share of any profits. The profit is clearly halal. Normally, the investor will take no role in managing the business.
  • Joint Venture Vehicles – known as musharaka, unlike mudarabah, the investor does get involved in the running of the business. Here investors each contribute capital to a business, sharing the profits in proportion to their original investments. As with venture capital financing, the fact that the investor is not guaranteed a return and risks loosing his capital makes any profits derived from this form of investment halal.

9. Conclusions

This article attempts to summarise a number of important principles and their practical consequences for preparing trusts for Muslim settlors. It is designed as an introduction to a complex area and clearly special care needs to be taken in particular cases to ensure that all relevant formalities are complied with.

 

John Riches and Christian Miceli
Withers LLP
London

john.riches@withersworldwide.com
Telephone +44 (0) 20 7597 6000