No Pain, No Gain: The State of the Industry in Light of an American Islamic Private Equity Transaction

I. INTRODUCTION Islamic finance is the recent attempt to bring into compliance with the Divine the finances and economies of both individuals and nations. This attempt follows from a recognition by Muslims that the assumptions, regulations, and objectives of the conventional financial order are not wholly consistent with their religion.1 It is one of the few areas in which there is an active, contemporary effort by Muslims and those of other faiths to implement the tenets of the Islamic religion to the challenges of the modern world.2 Islamic financial transactions regularly take place in jurisdictions, including Muslim majority nations as well as Europe and the US, in which Islamic law is not the law of the land. Frequently, these transactions play an instructive role because they represent instances of first impression in some form. These include cases where contemporary Muslim jurists have not yet issued legal opinions, or fatawa.3 Moreover, these transactions often necessitate creativity in response to the tensions that arise from the interaction between and required compliance with two or more legal systems, as well as from practical contemporary considerations. This Article focuses on the classical Islamic contract form of sharikab as it is currently implemented by contemporary Islamic private equity transactions. A number of key issues arising from a transaction, in which the author served as counsel to an Islamic investment bank acquiring a non-controlling share in a US company, are presented below to demonstrate the increasing ability of Islamic finance to implement a greater portion of its substantive concepts-a point that demonstrates the industry's successes in its initial phase. This transaction ("subject transaction") also shows the impact of Islamic principles on conventional private equity arrangements and highlights some similarities and differences between contemporary Islamic financial practice and classical jurisprudence.4 II. THE STATE OF THE INDUSTRY: SOME REFLECTIONS A common criticism of Islamic finance relates to whether it has remained true to classical Islamic law. Certain critics lament the absence of equity financing structures, despite their contended parallel with the "essence" of Islamic finance. These critics argue that Islamic laws pertaining to business transactions and finance place a strong emphasis on profit- and loss-sharing among transaction participants, including capital providers. In support of this argument, various texts, including the important hadith, which states "[Entitlement to] profit must be accompanied by a liability for loss," are often quoted.5 Proponents of this position generally find that the Islamic contract form known as sharikah,6 a form of joint ownership often translated as "partnership" and defined in greater detail below, most closely approximates modern conventional private equity transactions in which there is joint contractual ownership in an enterprise. To date, however, Islamic financial transactions have been based primarily on two alternative forms: the murabahah contract,7 and the ijarah contract.8 Proponents of musharakah, or of Islam's profit- and loss-sharing principles, lament the overuse of these two forms largely because they allow Islamic bankers to more easily and closely mimic the substance and economics of prohibited conventional financings, such as interest-bearing loans. While this contention is not without merit, it does not account for the youth of the Islamic finance industry among the other social, economic, and political realities in which the industry is situated. Given the current operational structure of Islamic banks and the nature of the risks involved in equity transactions, Islamic banks may not yet be fully ready to regularly undertake such investment transactions.9 Moreover, the use of murabahah- and ijarah-based transactions, and the current state of Islamic private equity, must both be understood in light of the goals of the Islamic finance industry's first phase. …