Sharia And The Chapter 11 Bankruptcy Problem

bahrain sharia and bankruptcy courtSome religions forbid people from charging interest on money loaned. A New York bankruptcy court shows that it doesn’t need to stand in the way of commerce.

We don’t talk about Chapter 11 bankruptcy here because I don’t usually take on those sorts of cases.  And we seldom discuss religion because it’s not often that matters of faith intersect with matters of money.

But the curious case of Arcapita caught my eye as an example of how faith and money collide in odd ways.

Bahrain’s Arcapita Bank took a rare and bold step of filing for bankruptcy in New York in March 2012, going against the common practice of Middle Eastern companies to engage in debt workouts relying solely on consensual talks.

The numbers aren’t important, but the company was faced with a difficult situation in fashioning a plan to repay creditors.

That problem was that Sharia, Islamic law, got in the way.

Interest-Free Lending?

Sharia prohibits the payment or acceptance of interest or fees in lending.  So, too, is it forbidden to invest in a business that provides goods or services considered contrary to Islamic principles.

This is similar to the Old Testament, which encourages loans to people so as to enable the poor to regain their independence, but forbids the charging of interest on the loan as being exploitative.

I’m sure there are other faiths and denominations that speak to a prohibition against charging or paying interest. If you know of one, let me know in the comments section below.

Arcapita’s Chapter 11 Problem

Unfortunately, business turns on the ability of the lender to obtain a return on investment that makes it a good idea to lend money in the first place.

Under Chapter 11 bankruptcy, you’re putting together a plan to repay your creditors over the long run.  Agreements are modified under court supervision, then the parties go off to perform accordingly.

But without the ability to pay interest to the largest secured creditor in the case, Arcapita was in a tight spot. If it didn’t agree to pay interest to the creditors, there’s no way a Chapter 11 Plan would get confirmed.

The Murabahah Solution

What if the loan would be repaid at a set price that already included a profit margin acceptable to Arcapita and the lender?

The lender is compensated for the time value of money in the form of a profit margin, the borrower can do the deal, and the Chapter 11 Plan can be confirmed.

That’s exactly what Arcapita did.  It’s called Murabahah, a “rent-to-own” type of arrangement that allows business to move forward. This is also how mortgages are often handled under Islamic law, fixing the costs at the time of contract.

No late payment penalties are allowed, which is why Islamic banks apparently ask for higher down payments to offset the risks of nonpayment.

Bankruptcy Court As Problem Solver

The Arcapita solution, which is the first Sharia-compliant Chapter 11 Plan on record in this country, shows that the bankruptcy court isn’t always a strict place to be.

Rather, I’ve found that in difficult situations it’s the bankruptcy court that helps fashion a solution that works for everyone.

In New York bankruptcy courts, loss mitigation allows the parties to come together to modify a home mortgage in ways that are at times extraordinary.

Disputes are handled, assets divided, and creditors made whole without being unfair to those who look for help.

This is an exceptionally unusual situation, but Arcapita’s Sharia-compliant Chapter 11 underscores just how well bankruptcy can work.

Image credit:  JohnConnell

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About the Author:

I've been a consumer protection lawyer since 1995, working to help people end their bill problems. I'm a faculty member at the Student Loan Law Workshop, a nationally recognized speaker, and a long-time member of both the National Association of Consumer Bankruptcy Attorneys and National Association of Consumer Advocates.