In Islamic Finance, the term wakala describes an agency or a delegated authority where a muwakkil (principal) appoints the wakil (agent) to carry out a specific job on behalf of the muwakkil.

In Brief:

  • Wakala agreements are agency agreements where the muwakkil and the wakil share in the profit and risk of loss of investment. Any guarantee on minimum return is not Shari'a compliant.
  • Capacity risk should be mitigated by due diligence and representations and warranties.
  • Governing law provisions ought not to be confused with Islamic Shari'a.
  • The funds of the muwakkil under a wakala agreement ought to be segregated if possible from the funds of the wakil to mitigate UAE insolvency risk.

Wakalas explained

The literal meaning of a "wakala" is an agency or a delegated authority where the muwakkil (principal) appoints the wakil (agent) to carry out a specific job on behalf of the muwakkil.

Under the general principles of Islamic Shari'a, a wakala agreement is an agency agreement whereby the wakil acts as agent for the muwakkil in accordance with the provisions of the wakala. An action performed by the wakil as an agent on behalf of the muwakkil is deemed an action by the muwakkil himself. However, the wakil is under a duty of care and skill to act diligently when performing his obligations.

The subject matter of the agency and the obligations of the wakil should be known and defined and should not contravene Islamic Shari'a principles. Agency is not permissible in acts prohibited under Islamic Shari'a such as selling alcohol or gambling and acts of disobedience such as theft, unlawful seizure of property or conducting riba-based business (usury).

There are various types of wakalas used in Islamic finance, the most common of which is "wakalat istithmar" meaning a service agency for the management of funds. In return for undertaking investment services, Islamic financial institutions are paid a pre-agreed agency fee (which can be relatively nominal) for carrying out investments under wakala agreement on the basis of sharing in the profit and loss in the investment.

The wakil must perform its obligations according to the instructions of the muwakkil and must act in good faith and use reasonable care and skill when performing his functions. Where the wakil suffers loss while performing his functions, such loss should be borne by the muwakkil as principal under the wakala agreement provided that there is no willful, default fraud or gross negligence on the part of the wakil. The basic principle under such arrangements is that the parties may gain or lose depending on the performance of the investment.

Guarantee on return

It is noted that a number of wakala agreements contain provisions that aim to guarantee the muwakkil a certain profit or a minimum return on the principal amount. It is arguable that a wakala with such provisions contravenes Islamic Shari'a principles as it is a basic principle of Islamic investment that the amounts invested and the returns on such investment cannot be guaranteed by the wakil. The wakala by nature is an agency agreement and not a conventional deposit account arrangement that guarantees a fixed return.

Under a wakala agreement the muwakkil and the wakil both share in the profit and the risk of loss. The expected profits specified in a wakala agreement are indicative only and do not constitute a guarantee of the return. If the wakil makes a profit by the maturity date, the profits are shared with the muwakkil in pre-agreed proportions. Conversely, if a loss is made this loss is borne by the muwakkil in the absence of gross negligence, fraud or wilful default by the wakil.

The notion of sharing in the profit and the risk of loss is corroborated by in the UAE Civil Code. The principles of the Civil Code emphasise that an agent shall not be liable for any losses if the investments made do not yield any returns, provided that the agent acts in accordance with the terms of his agency.

Business plan

The wakil is often required to present a business plan or a feasibility report to the muwakkil before the muwakkil agrees on investing its money with the wakil. Such business plan is often indicative of the returns that the wakil expects to make on the investment. In a normal market, feasibility reports may be relied on by the muwakkil in order to decide whether to invest with the wakil or not, however where the market is volatile relying on such reports may be a problem. Where the economy is witnessing a downturn, such predictions should not be solely relied on by the muwakkil as the expected profits are unlikely to be achieved. Therefore, when entering into a wakala agreement the muwakkil must be aware of the fact that any loss on its investment by the wakil will be borne by the muwakkil himself.

Having references to EIBOR or LIBOR as a threshold for calculating the expected profits which the wakil is to generate or the late payment amount, has also been argued to be haram because the calculation of the threshold is based on a conventional bank's calculation of the cost of its money either to borrow or to lend and therefore may be deemed riba (usury or interest) as it is based on the cost of money which is technically not allowed under Shari'a Principles. The counter argument is that the reference to EIBOR or LIBOR is merely a threshold reference rate calculation for the profit and not the basis of the profit itself.

Capacity and investment risk

The issue of guaranteeing a minimum return on the muwakkil's investment raises further questions in relation to the capacity of the wakil to give such guarantees and whether or not the wakil can renounce his obligations under the wakala agreement on the basis of lack of capacity. This point was highlighted in the recent case of the Kuwait-based company The Investment Dar (TID) and BLOM Development Bank SAL of Lebanon (Blom Bank). Blom Bank sued TID in the High Court of Justice in London last year to recover US$10.7 million it had invested with TID in 2007 as well as a 5% return promised in the terms of the wakala. TID refused to pay, arguing that the deal was not Shari'a compliant as the 5% return could be seen as 'interest' which is forbidden under Islam, and TID's charter prohibited it from entering into non-Islamic transactions. TID argued it was acting ultra vires. The matter whilst never being tried and subsequently not proceeding raised the issue of capacity risk in Islamic transactions.

Despite TID's statutes and the terms of the Wakala with Blom Bank allegedly showing TID to be acting ultra vires due to its apparent conflict with Islamic principles TID's Shari'a board issued a fatwa stating that the wakala was a valid Islamic contract. This case highlighted the issue of capacity risk and has caused Islamic finance institutions to come under scrutiny, by rating agencies that are now prompted to evaluate additional risks when assessing such transactions.

It is therefore recommended that measures are taken such as representations and warranties be included in wakalas to underpin capacity and Islamic Sharia compliance and to provide expressly that neither wakil nor muwakkil can renege on their stated contractual obligations on the basis of non-compliance with Sharia or ultra vires.

Governing law

Many wakalas provide that the governing laws of the contract are UAE laws to the extent that these laws do not conflict with the provisions of Islamic Shari'a. We note that this may cause some confusion in case of dispute, where an act may have been deemed illegal or lacking capacity under UAE laws but a Shari'a board declares it valid and legal or vice versa. Shari'a scholars' evidence ought to assist the court to determine if a deal was compliant but ultimately the courts will decide the case. Having both the UAE laws and the principles of Islamic Shari'a govern a wakala agreement will be problematic. The dynamics between law and doctrines is complex, however what is clear is that the governing laws are fixed whereas fatwas declared by Shari'a scholars are issued in relation to a particular deal and may vary from one Shari'a Board to another and from one deal to another.

Clauses in wakala contracts that provide for Islamic Shari'a to prevail in case of conflict or ambiguity with governing laws should not be encouraged.

Mixing of funds

Where a Muwakkil invests money with the wakil under a wakala, such money is usually mixed with the wakil's own pool of funds. In the event that the wakil becomes insolvent, the muwakkil's money will be mixed with the wakil's other money and may well be treated by the liquidator in a UAE law governed insolvency as part of the wakil's liquidation assets.

Investors are advised to consider this risk when investing their funds under a wakala agreement in the UAE absent insolvency remote trust laws.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.