The Principle of Non-Entitlement of Islamic Financial Institutions to Default Interest, Even by Way of Compensation.

Practice Area: Banking & Finance Law – Islamic Finance / Commercial Transactions

Outcome: Islamic financial institutions and takaful companies cannot claim default interest or any financial benefit on delayed debts, even as compensation. Any agreement to the contrary is absolutely void, establishing a binding precedent for all Dubai courts.

I. Background and Procedural History

In a public session held at the Dubai Court of Cassation, the General Authority of the Cassation Court examined an appeal referred by the Chief Justice of the Court of Cassation. The referral arose from conflicting judgments concerning the interpretation and application of Federal Decree-Law No. (50) of 2022, issuing the Commercial Transactions Law, specifically as to whether Islamic financial institutions may claim default interest as compensation for delayed payment.

The Court observed that certain judgments had permitted Islamic financial institutions to charge default interest at a rate of 5% per annum from the date of the judicial claim until full settlement, treating such interest as compensation for delay. Other judgments, however, had held that such recovery was impermissible, based on the express provisions of Article (473) of the same law.

In light of this divergence, the Chief Justice referred the issue to the General Authority for resolution pursuant to Article (20) of the Law No. 13/2016 On the Judicial Authority in the Emirate of Dubai. After registration of the matter and the scheduling of a hearing on 9 July 2025, the General Authority deliberated and issued its decision on 14 July 2025.

II. The Court’s Reasoning and Legal Foundations

The General Assembly held that the provisions contained in Chapter Six, Book Three of the Commercial Transactions Law particularly Articles (468), (472), (473), and (474) clearly regulate commercial transactions of Islamic financial institutions and takaful (Islamic insurance) companies that conduct all or part of their business in accordance with the principles of Islamic Sharia, under a license from the competent authorities.

The Court emphasized that the legislature has established a mandatory rule prohibiting such institutions from borrowing or lending with interest or benefit in any form. They are likewise prohibited from claiming any interest or financial benefit on debts delayed in payment, whether such benefit is labeled “default interest” or “compensation for delay.” Any such recovery would constitute a direct violation of Sharia principles and public policy.

The Court noted that Article (473) of the Commercial Transactions Law expressly and unequivocally prohibits any agreement or arrangement that results in the imposition of default interest or any additional financial benefit on debt in Islamic transactions. Any agreement to the contrary is absolutely null and void, as the prohibition relates to public policy, which courts must apply ex officio, without the need for any party to raise it.

Relying on Articles (472) and (474), the Court further reasoned that financial obligations arising from Islamic transactions must be specific and certain in amount, and their value may not increase by reason of postponement or delay in payment. Any such increase would contradict the essence of Sharia-compliant commercial dealings, which are founded on fairness, balance, and the avoidance of both explicit and implicit usury.

Accordingly, the General Authority resolved to depart from all previous judgments inconsistent with this principle, thereby unifying judicial interpretation and practice on the matter.

 

III. Conclusion and Established Legal Principle

The General Authority of the Cassation Court concluded by establishing the following binding judicial principle:

“Islamic financial institutions and takaful companies conducting all or part of their business in accordance with the principles of Islamic Sharia are not entitled to claim any default interest or financial benefit, even by way of compensation, on any debt or financial obligation arising from a transaction or commercial contract governed by Sharia principles. Any agreement to the contrary is absolutely void, as it contravenes public policy.”

This principle reaffirms that Sharia law constitutes the governing framework for commercial dealings of Islamic financial institutions. Federal Decree-Law No. (50) of 2022 has thus conclusively settled any differing interpretations, rendering the prohibition of default interest both a legal and Sharia-based obligation, impervious to contractual modification or waiver.

Through this ruling, the General Authority has established a decisive and binding precedent for all Courts in the Emirate of Dubai, representing a cornerstone interpretive principle in the application of the Commercial Transactions Law. It enhances legal clarity in Sharia-compliant commercial contracts and financial obligations, ensuring the stability and integrity of financial transactions.

IV. Practical Impact on the UAE Islamic Banking System

This 2025 ruling by the General Authority of the Cassation Court represents a significant judicial development in regulating Islamic banking transactions and unifying judicial interpretation concerning default interest. The Court held that Islamic financial institutions and takaful companies are prohibited from charging any additional amount on debt even if described as “compensation pursuant to Article (473) of the Commercial Transactions Law, which expressly forbids such practices and classifies them as matters of public policy.

The decision serves to harmonize judicial approaches across the UAE in the field of Islamic finance, reinforce compliance by financial institutions with applicable legal and regulatory frameworks, and require them to adopt legitimate and Sharia-compliant means of compensation in cases of delayed payment.

By striking this balance between creditor protection and transactional stability, the ruling affirms that the UAE judiciary is committed to fostering a disciplined financial environment consistent with the legislative objectives of economic justice, legal certainty, and confidence in the banking system.