Ijarah is a term of Islamic
fiqh. Lexically it means to give something on rent. In the Islamic
jurisprudence, the term ijarah is used for two different situations:
- To employ the services of a person on wages given to him as a consideration for his hired services.’ The employer is called musta’jir while the employee is called ajir.Therefore, if A has employed B in his office as a manager or as a clerk on a monthly salary, A is musta’jir, and B is an ajir. Similarly, if A has hired the services of a porter to carry his baggage to the airport, A is a musta’jir while the porter is an ajir, and in both cases the transaction between the parties is termed as ijarah. This type of ijarah includes every transaction where the services of a person are hired by someone else. He may be a doctor, a lawyer, a teacher, a laborer or any other person who can render some valuable services. Each one of them may be called an ‘ajir’ according to the terminology of Islamic law, and the person who hires their services is called a ‘musta’jir’, while the wages paid to the ajir are called their ‘ujrah’.
- The second type of ijarah relates to the usufructs of assets and properties, and not to the services of human beings. ‘Ijarah’ in this sense means ‘to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.’ In this case, the term ‘ijarah’ is analogous to the English term ‘leasing’. Here the lessor is called ‘mu’jir’, the lessee is called ‘musta’jir’ and the rent payable to the lessor is called ‘ujrah’. Both these kinds of ‘ijarah’ are thoroughly discussed in the literature of Islamic jurisprudence and each one of them has its own set of rules. But for the purpose of the present book, the second type of ijarah is more relevant, because it is generally used as a form of investment, and as a mode of financing also.
Ijarah is about the
contract between a lessor and lessee in which the lessor being the owner of the
property allows the lessee to enjoy the usufructs of the property at agreed
terms of the rental and period of lease.
From Islamic bank view, al
Ijarah usually refers to an Islamic leasing contract of land, property or
equipment, which is leasing to a client
for stream of rental payments. Leasing
is an agreement that permits one party (the lessee) to use an asset or property
owned by another party (the lessor) for an agreed-upon price over a fixed
period of time.
Ijarah contract is
permissible under the shari’ah based on the following:
Allah says in the Qur’an,
“and if they suckle your (offspring), gives them their recompense” (surah al –
Talaq, verses 6)
It was narrated by Abu
Hurairah that Prophet Muhammad (s.a.w) said, “He who hire a worker must inform
him of his wage” (Reported by Al – Baihaqi)
Elements
of Ijarah
There are five essential
elements of contract of utilizing the usufruct or ijarah as follow:
- Lessor and lessee
They must be capable of
taking responsibilities, that is to say they are a sound mind and have reached
the age puberty and age of majority
They must not be
prohibited from dealing with their properties, specifically they are not
declared bankrupts or prodigal
No coercion is exerted on
either of them
- Property
It must be owned by the
lessor
It must be ready for use
It must be delivered to
the lessee
It must be specific by
address, description or specification
- Benefit (use or usufruct)
It must be permissible
It can be fixed in value
The lessor has the power
and capability to provide the benefit and allow lessee to use the property
It must be specified
The benefit must not be
the material part of the property
- Rental
It must be in known
currency for example in Ringgit Malaysia, US dolar etc. It is not sufficient to
state that the rental is 500 without specifying that the rental is to be paid
in what currency.
It must be in absolute
amount
- Contract
- The offer and acceptance must be absolute and in definite and decisive language. Therefore, it must not be conditional, it must not be fixed to certain time like a certain day or date or limited to a certain period of time, and it must be in the present or past tense and not in future tense nor imperative
- The acceptance must agree with the offer
- The offer and acceptance must be made at one and the same meeting
Types
of Ijarah Contract
There are three types of
Ijarah contract is use:
Al Ijarah (tashghiliyah) is about operating Ijarah. Where the Ijarah contracts that do not end up with the transfer of ownership of leased asset to the lessee.
Al Ijarah muntahia bitamleek, is the Ijarah with option to transfer the ownership of asset to the lessee. Ijarah mumtahia Bitamleek may take one of the following forms:
- Ijarah mumtahia bitamleek that transfer the ownership of leased assets to lessee, if the lessee do desires to make it, and for a price represented by the rental payments made by lessee over the lease term. After the last installment is paid, legal title of leased automatically passes to lessee because of the new contract.
- Ijarah mumtahia bitamleek gives the lessee the right of ownership of leased assets at the end of the lease term because of a new contract for a specified price, which may be in a token price.
- Ijarah agreements that gives the lessee one of the three option that may exercise at th end of the lease term:
- Purchasing the leased asset for a price that is determined based rental payments made by the lessee
- Renewal of Ijarah for another term
- Returning the leased asset to the lessor, means that owner
A composite contract, al
Ijarah thumma al – bai means Ijarah that follow by sale and is practiced in
Malaysia.
The rules of ijarah, in the
sense of leasing, is very much analogous to the rules of sale, because in both
cases something is transferred to another person for a valuable consideration.
The only difference between ijarah and sale is that in the latter case the
corpus of the property is transferred to the purchaser, while in the case of
ijarah, the corpus of the property remains in the ownership of the transferor,
but only its usufruct i.e. the right to use it, is transferred to the lessee.
Therefore, it can easily be
seen that ijarah is not a mode of financing in its origin. It is a normal
business activity like sale. However, due to certain reasons, and in
particular, due to some tax concessions it may carry, this transaction is being
used in the western countries for the purpose of financing also. Instead of
giving a simple interest - bearing loan, some financial institutions started
leasing some equipment’s to their customers. While fixing the rent of these
equipment, they calculate the total cost they have incurred in the purchase of
these assets and add the stipulated interest they could have claimed on such an
amount during the lease period. The aggregate amount so calculated is divided
on the total months of the lease period, and the monthly rent is fixed on that
basis. The question whether or not the transaction of leasing can be used as a
mode of financing in Shari‘ah depends on the terms and conditions of the
contract. As mentioned earlier, leasing is a normal business transaction and
not a mode of financing. Therefore, the lease transaction is always governed by
the rules of Shari‘ah prescribed for ijarah. Let us, therefore, discuss the
basic rules governing the lease transactions, as enumerated in the Islamic
Fiqh. After the study of these rules, we will be able to understand under what
conditions the ijarah may be used for the purpose of financing. Although the
principles of ijarah are so numerous that a separate volume is required for
their full discussion, we will attempt in this chapter to summarize those basic
principles only which are necessary for the proper understanding of the nature
of the transaction and are generally needed in the context of modern economic
practice. These principles are recorded here in the form of brief notes, so
that the readers may use them for quick reference.
BASIC RULES OF LEASING
- Leasing is a contract whereby the owner of something transfers its usufruct to another person for an agreed period, at an agreed consideration.
- The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased.
- It is necessary for a valid contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything which cannot be used without consuming cannot be leased out. Therefore, the lease cannot be effected in respect of money, eatables, fuel and ammunition etc. because their use is not possible unless they are consumed. If anything of this nature is leased out, it will be deemed to be a loan and all the rules concerning the transaction of loan shall accordingly apply. Any rent charged on this invalid lease shall be an interest charged on a loan.
- As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee. Example: A has leased his house to B. The taxes referable to the property shall be borne by A, while the water tax, electricity bills and all expenses referable to the use of the house shall be borne by B, the lessee.
- The period of lease must be determined in clear terms.
- The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. If no such purpose is specified in the agreement, the lessee can use it for whatever purpose it is used in the normal course. However if he wishes to use it for an abnormal purpose, he cannot do so unless the lessor allows him in express terms.
- The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence on the part of the lessee.
- The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.
- A property jointly owned by two or more persons can be leased out, and the rental shall be distributed between all the joint owners according to the proportion of their respective shares in the property.
- A joint owner of a property can lease his proportionate share to his co-sharer only, and not to any other person.
- It is necessary for a valid lease that the leased asset is fully identified by the parties. Example: A said to B. “I lease you one of my two shops.” B agreed. The lease is void, unless the leased shop is clearly determined and identified.
- The rental must be determined at the time of contract for the whole period of lease. It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of effecting a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid. Example (1): A leases his house to B for a total period of 5 years. The rent for the first year is fixed as Rs. 2000/- per month and it is agreed that the rent of every subsequent year shall be 10% more than the previous one. The lease is valid.E xample (2): In the above example, A puts a condition in the agreement that the rent of Rs. 2000/- per month is fixed for the first year only. The rent for the subsequent years shall be fixed each year at the option of the lessor. The lease is void, because the rent is uncertain.
- The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shari‘ah, if both parties agree to it, provided that all other conditions of a valid lease prescribed by the Shari‘ah are fully adhered to.
- The lessor cannot increase the rent unilaterally, and any agreement to this effect is void.
- The rent or any part there of may be payable in advance before the delivery of the asset to the lessee, but the amount so collected by the lessor shall remain with him as ‘on account’ payment and shall be adjusted towards the rent after its being due.
- The lease period shall commence from the date on which the leased asset has been delivered to the lessee, no matter whether the lessee has started using it or not.
- If the leased asset has totally lost the function for which it was leased, and no repair is possible, the lease shall terminate on the day on which such loss has been caused. However, if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to compensate the lessor for the depreciated value of the asset as, it was immediately before the loss.
LEASE AS A MODE OF
FINANCING
Like murabahah, lease is
not originally a mode of financing. It is simply a transaction meant to
transfer the usufruct of a property from one person to another for an agreed
period against an agreed consideration. However, certain financial institutions
have adopted leasing as a mode of financing instead of long term lending on the
basis of interest. This kind of lease is generally known as the ‘financial
lease’ as distinguished from the ‘operating
lease’ and many basic features of actual leasing transaction have been
dispensed with therein.
FINANCIAL LEASE - A
finance lease is mainly a method of raising long-term finance to pay for
assets. It provides the lessor with full recovery of its investment and a
reasonable profit over the initial non-cancelable lease term. Financial leases
have some similar feature to secured loans. Both allow a business to use an
asset, such as equipment, over a fixed period, in return for regular payments.
The business client chooses the equipment it requires and the bank buys it on
behalf of the business. After all the payments have been made, the business
client becomes the owner of the equipment. The lessor's rate of return is fixed
and is not dependent upon the asset-value, performance, or any other extraneous
costs. The fixed lease rentals give rise to an ascertainable rate of return on
investment. Therefore, by spreading payments out over the lifecycle of the
asset, the business is able to align the cost with the benefit derived from the
use of the leased asset. The lessor generally would not provide any services
relating to operation of the asset. In addition, financial leases are
non-cancellable.
OPERATING LEASE - On the
other hand, when a risk is involving other than a plain financial risk in a
lease, it is an operating lease. In fact, an operating lease is similar to a
rental agreement, and is not a finance lease for the purpose of acquiring
assets; operating leases take innumerable forms based on the risks the lessor
takes or avoids, and the involvement of the lessor in operation of the asset.
Operating leases are also referred to as a “non-full payout” leases, because
the amount of the rental does not cover the lessor’s full capital outlay for
the expected economic life of an asset, the minimum lease payments over the lease
term are such as to secure for the lessor the recovery of his capital outlay
plus a market return on funds invested and the lease period is always less than
the working life of the asset.
THE DIFFERENT FINANCIAL
LEASE AND OPERATING LEASE
The basic features that
differentiate an operating lease from a financial lease are related to whether
the lessor or the lessee takes on the risks of ownership of the leased assets.
- Operating leases do
not put the lessee in the position of a virtual owner; the lessee is
simply using the asset for an agreed period. Also, there is always a
dependence on the lessee's commitment to pay, as a result, the lessor also
takes is asset-based. Its rate of return in an operating lease is
dependent upon the asset value, performance, or costs relating to the
asset; and is always a matter of probabilities and uncertainty. Therefore,
in an operating lease, the lessor normally holds a stock of assets with
high degree of marketability to provide to other entities. He may also
provide any services relating to these assets, such as maintenance or
operations. The assets remain property of the lessor who has the option to
re-lease them every time the lease period terminates. Accordingly, the
lessor bears the risk of obsolescence, recession or diminishing
demand.
- Financial lease provider operates
like a lender except that the lessor has the additional collateral of
legal ownership of the assets without any of the risks associated with
ownership.
When interest-free
financial institutions were established in the near past, they found that
leasing is a recognized mode of finance throughout the world. On the other
hand, they realized that leasing is a lawful transaction according to Shari‘ah
and it can be used as an interest-free mode of financing.Therefore, leasing has
been adopted by the Islamic financial institutions, but very few of them paid
attention to the fact that the ‘financial lease’ has a number of
characteristics more similar to interest than to the actual lease transaction.
That is why they started using the same model agreements of leasing as were in
vogue among the conventional financial institutions without any modification, while
a number of their provisions were not in conformity with Shari‘ah. As mentioned
earlier, leasing is not a mode of financing in its origin. However, the
transaction may be used for financing, subject to certain conditions. It is not
sufficient for this purpose to substitute the name of ‘interest’ by the name of
‘rent’ and replace the name of ‘mortgage’ by the name of ‘leased asset’. There
must on be a substantial difference between leasing and an interest-bearing
loan. That will be possible only by following all the Islamic rules of leasing,
some of which have been mentioned in the first part of this chapter.To be more
specific, some basic differences between the contemporary financial leasing and
the actual leasing allowed by the Shari‘ah are indicated below :
1. THE COMMENCEMENT OF LEASE
Unlike the contract of
sale, the agreement of ijarah can be effected for a future date. Thus, while a
forward sale is not allowed in Shari‘ah, an ‘ijarah’ for a future date is
allowed, on the condition that the rent will be payable only after the leased
asset is delivered to the lessee. In most cases of the ‘financial lease’ the
lessor i.e. the financial institution purchases the asset through the lessee
himself. The lessee purchases the asset on behalf of the lessor who pays its
price to the supplier, either directly or through the lessee. In some
lease agreements, the lease commences on the very day on which the price is
paid by the lessor, irrespective of whether the lessee has effected payment to
the supplier and taken delivery of the asset or not. It may mean that lessee’s
liability for the rent starts before the lessee takes delivery of the asset.
This is not allowed in Shari‘ah, because it amounts to charging rent on the
money given to the customer which is nothing but interest, pure and simple. The
correct way, according to Shari‘ah, is that the rent be charged after the
lessee has taken delivery of the asset, and not from the day the price has been
paid. If the supplier has delayed the delivery after receiving the full price,
the lessee should not be liable for the rent of the period of delay.
2. DIFFERENT RELATIONS OF
THE PARTIES
It should be clearly
understood that when the lessee himself has been entrusted with the purchase of
the asset intended to be leased, there are two separate relations between the
institution and the client which come into operation one after the other. In
the first instance, the client is an agent of the institution to purchase the
asset on latter’s behalf. At this stage, the relation between the parties is
nothing more than the relation of a principal and his agent. The relation of
lessor and lessee has not yet come into operation.
The second stage begins
from the date when the client takes delivery from the supplier. At this stage,
the relation of lessor and lessee comes to play its role. These two capacities
of the parties should not be mixed up or confused with each other. During the
first stage, the client cannot be held liable for the obligations of a lessee.
In this period, he is responsible to carry out the functions of an agent only.
But when the asset is delivered to him, he is liable to discharge his
obligations as a lessee. However, there is a point of difference between
murabahah and leasing. In murabahah, as mentioned earlier, actual sale should
take place after the client takes delivery from the supplier, and the previous
agreement of murabahah is not enough for effecting the actual sale. Therefore,
after taking possession of the asset as an agent, he is bound to give
intimation to the institution, and make an offer for the purchase from him. The
sale takes place after the institution accepts the offer. The procedure in
leasing is different, and a little shorter. Here the parties need not effect
the lease contract after taking delivery. If the institution, while appointing
the client its agent, has agreed to lease the asset with effect from the date
of delivery, the lease will automatically start on that date without any
additional procedure. There are two reasons for this difference between
murabahah and leasing:
- Firstly, it is a necessary condition for a valid
sale that it should be effected instantly. Thus, a sale attributed to a
future date is invalid in Shari‘ah. But leasing can be attributed to a
future date. Therefore, the previous agreement is not sufficient in the
case of murabahah, while it is quite enough in the case of leasing.
- Secondly, the basic principle of Shari‘ah is that
one cannot claim a profit or a fee for a property the risk of which was
never borne by him. Applying this principle to murabahah, the seller
cannot claim a profit over a property which never remained under his risk
for a moment. Therefore, if the previous agreement is held to be
sufficient for effecting a sale between the client and the institution,
the asset shall be transferred to the client simultaneously when he takes
its possession, and the asset shall not come into the risk of the seller
even for a moment. That is why the simultaneous transfer is not possible
in murabahah, and there should be a fresh offer and acceptance after the
delivery.
In leasing, however, the
asset remains under the risk and ownership of the lessor throughout the leasing
period, because the ownership has not been transferred. Therefore, if the lease
period begins right from the time when the client has taken delivery, it does
not violate the principle mentioned above.
3. EXPENSES CONSEQUENT TO
OWNERSHIP
As the lessor is the owner
of the asset, and he has purchased it from the supplier through his agent, he
is liable to pay all the expenses incurred in the process of its purchase and
its import to the country of the lessor. Consequently, he is liable to pay the
freight and the customs duty etc. He can, of course, include all these expenses
in his cost and can take them into consideration while fixing the rentals, but
as a matter of principle, he is liable to bear all these expenses as the owner
of the asset. Any agreement to the contrary, as is found in the traditional
financial leases, is not in conformity with Shari‘ah.
4. LIABILITY OF THE PARTIES
IN CASE OF LOSS TO THE ASSET
As mentioned in the basic
principles of leasing, the lessee is responsible for any loss caused to the
asset by his misuse or negligence. He can also be made liable to the wear and
tear which normally occurs during its use. But he cannot be made liable to a
loss caused by the factors beyond his control. The agreements of the
traditional ‘financial lease’ generally do not differentiate between the two
situations. In a lease based on the Islamic principles, both the situations
should be dealt with separately.
5. VARIABLE RENTALS IN LONG
TERM LEASES
In the long term lease
agreements it is mostly not in the benefit of the lessor to fix one amount of
rent for the whole period of lease, because the market conditions change from
time to time. In this case the lessor has two options:
(a) He can contract lease with
a condition that the rent shall be increased according to a specified
proportion (e.g. 5%) after a specified period (like one year).
(b) He can contract lease
for a shorter period after which the parties can renew the lease at new terms
and by mutual consent, with full liberty to each one of them to refuse the
renewal, in which case the lessee is bound to vacate the leased property and
return it back to the lessor. These two options are available to the lessor
according to the classical rules of Islamic Fiqh. However, some contemporary
scholars have allowed, in long-term leases, to tie up the rental amount with a
variable benchmark which is so well-known and well-defined that it does not
leave room for any dispute. For example, it is permissible according to them to
provide in the lease contract that in case of any increase in the taxes imposed
by the government on the lessor, the rent will be increased to the extent of
same amount. Similarly it is allowed by them that the annual increase in the
rent is tied up with the rate of inflation. Therefore if there is an increase
of 5% in the rate of inflation, it will result in an increase of 5% in the rent
as well. Based on the same principle, some Islamic banks use the rate of
interest as a benchmark to determine the rental amounts. They want to earn the
same profit through leasing as is earned by the conventional banks through
advancing loans on the basis of interest. Therefore, they want to tie up the
rentals with the rate of interest and instead of fixing a definite amount of
rental, they calculate the cost of purchasing the lease assets and want to earn
through rentals an amount equal to the rate of interest. Therefore, the
agreement provides that the rental will be equal to the rate of interest or to
the rate of interest plus something. Since the rate of interest is variable, it
cannot be determined for the whole lease period.
Therefore, these contracts
use the interest rate of a particular country (like LIBOR) as a benchmark for
determining the periodical increase in the rent.
This arrangement has been
criticized on two grounds:
The first objection raised
against it is that, by subjecting the rental payments to the rate of interest,
the transaction is rendered akin to an interest based financing. This objection
can be overcome by saying that, as fully discussed in the case of murabahah,
the rate of interest is used as a benchmark only. So far as other requirements
of Shari‘ah for a valid lease are properly fulfilled, the contract may use any
benchmark for determining the amount of rental. The basic difference between an
interest - based financing and a valid lease does not lie in the amount to be
paid to the financier or the lessor.The basic difference is that in the case of
lease, the lessor assumes the full risk of the corpus of the leased asset. If
the asset is destroyed during the lease period, the lessor will suffer the
loss. Similarly,if the leased asset looses its usufruct without any misuse or
negligence on the part of the lessee, the lessor cannot claim the rent, while
in the case of an interest-based financing, the financier is entitled to
receive interest, even if the debtor did not at all benefit from the money
borrowed. So far as this basic difference is maintained, (i.e. the lessor
assumes the risk of the leased asset) the transaction cannot be categorised as
an interest-bearing transaction, even though the amount of rent claimed from
the lessee is equal to the rate of interest. It is thus clear that the use of
the rate of interest merely as a benchmark does not render the contract invalid
as an interest - based transaction. It is, however, advisable at all times to
avoid using interest even as a benchmark, so that an Islamic transaction is
totally distinguished from an un-Islamic one, having no resemblance of interest
whatsoever.
The second objection to
this arrangement is that the variations of the rate of interest being unknown,
the rental tied up with the rate of interest will imply jahalah and gharar
which is not permissible in Shari‘ah. It is one of the basic requirements of
Shari‘ah that the consideration in every contract must be known to the parties
when they enter into it. The consideration in a transaction of lease is the
rent charged from the lessee, and therefore it must be known to each party
right at the beginning of the contract of lease. If we tie up the rental with
the future rate of interest, which is unknown, the amount of rent will remain
unknown as well. This is the jahalah or gharar which renders the transaction
invalid. Responding to this objection, one may say that the jahalah has been
prohibited for two reasons:
One reason is that it may
lead to dispute between the parties. This reason is not applicable here,
because both parties have agreed with mutual consent upon a well defined
benchmark that will serve as a criterion for determining the rent, and whatever
amount determined, based on this benchmark, will be acceptable to both parties.
Therefore, there is no question of any dispute between them.
The second objection for
the prohibition of jahalah is that it renders the parties susceptible to an
unforeseen loss. It is possible that the rate of interest, in a particular
period, zooms up to an unexpected level in which case the lessee will suffer.
It is equally possible that the rate of interest zooms down to an unexpected
level, in which case the lessor may suffer. In order to meet the risks involved
in such possibilities, it is suggested by some contemporary scholars that the
relation between the rent and the rate of interest is subjected to a limit of
ceiling. For example, it may be provided in the base contract that rental
amount after a given period, will be changed according to the change in the
rate of interest, but it will in no case be higher than 15% or lower than 5% of
the previous monthly rent.It will mean that if the increase in the rate of
interestis more than 15% the rent will be increased only up to 15%. Conversely,
if the secrease in the aret of interestis more than 5% the rent will not be
decresed to more than 5%. In our opinion, this is the moderate view which takes
care of all the aspects involved in the issue.
6.
PENALTY FOR LATE PAYMENT OR RENT
In some agreements of
financial leases, a penalty is imposed on the lessee in case he delays the
payment of rent after the due date. This penalty, if meant to add to the income
of the lessor, is not warranted by the Shari‘ah. The reason is that the rent after
it becomes due, is a debt payable by the lessee, and is subject to all the
rules prescribed for a debt. A monetary charge from a debtor for his late
payment is exactly the riba prohibited by the Holy Qur’an. Therefore, the
lessor cannot charge an additional amount in case the lessee delays payment of
the rent.
However, in order to avoid
the adverse consequences resulting from the misuse of this prohibition, another
alternative may be resorted to. The lessee may be asked to undertake that, if
he fails to pay rent on its due date, he will pay certain amount to a charity.
For this purpose the financier / lessor may maintain a charity fund where such
amounts may be credited and disbursed for charitable purposes, including
advancing interest-free loans to the needy persons. The amount payable for
charitable purposes by the lessee may vary according to the period of default
and may be calculated at per cent, per annum basis. The agreement of the lease
may contain the following clause for this purpose:
The Lessee hereby
undertakes that, if he fails to pay rent at its due date, he shall pay an
amount calculated at ....% p.a. to the charity Fund maintained by the Lessor
which will be used by the Lessor exclusively for charitable purposes approved
by the Shari‘ah and shall in no case form part of the income of the Lessor.
This arrangement, though does not compensate the lessor for his opportunity
cost of the period of default, yet it may serve
as a strong deterrent for the lessee to pay the rent promptly. The justification
for such undertaking of the lessee, and inability of any penalty or
compensation claimed by the lessor for his own benefit is discussed in full in
the chapter of murabahah in the present book which may be consulted for
details.
7.
TERMINATION OF LEASE
If the lessee contravenes
any term of the agreement, the lessor has a right to terminate the lease
contract unilaterally. However, if there is no contravention on the part of the
lessee, the lease cannot be terminated without mutual consent.
In some agreements of the
‘financial lease’ it has been noticed that the lessor has been given an
unrestricted power to terminate the lease unilaterally whenever he wishes,
according to his sole judgment. This is again contrary to the principles of
Shari‘ah. In some agreements of the ‘financial lease’ a condition has been
found to the effect that in case of the termination of lease,
even at the option of the lessor, the rent of the remaining lease period shall
be paid by the lessee. This condition is obviously against Shari‘ah and the
principles of equity and justice. The basic reason for inserting such
conditions in the agreement of lease is that the main concept behind the
agreement is to give an interest-bearing loan under the ostensible cover of
lease. That is why every effort is made to avoid the logical consequences of
the lease contract.
Naturally, such a condition
cannot be acceptable to Shari‘ah. The logical consequence of the termination of
lease is that the asset should be taken back by the lessor. The lessee should
be asked to pay the rent as due up to the date of termination. If the
termination has been effected due to the misuse or negligence on the part of
the lessee, he can also be asked to compensate the lessor for the loss caused
by such misuse or negligence. But he cannot be compelled to pay the rent of the
remaining period.
8.
INSURANCE OF THE ASSETS
If the leased property is
insured under the Islamic mode of takaful, it should be at the expense of the
lessor and not at the expense of the lessee, as is generally provided in the
agreements of the current ‘financial leases’.
9. THE
RESIDUAL VALUE OF THE LEASED ASSET
Another important feature
of the modern ‘financial leases’ is that after the expiry of the lease period,
the corpus of the leased asset is normally transferred to the lessee. As the
lessor already recovers his cost along with an
additional profit thereon, which is normally equal to the amount of interest
which could have been earned on a loan of that amount advanced for that period,
the lessor has no further interest in the leased
asset. On the other hand, the lessee wants to retain the asset after the expiry
of the leased period. For these reasons, the
leased asset is generally transferred to the lessee at the end of the lease,
either free of any charge or at a nominal token price. In order to ensure that
the asset will be transferred to the lessee, sometimes the lease contract has
an express clause to this effect. Sometimes this condition is not mentioned in
the contract expressly; however, it is understood between the parties that the
title of the asset will be passed on to the lessee at the end of the lease
term. This condition, whether it is express or implied, is not in accordance
with the principles of Shari‘ah. It is a well settled rule of Islamic
jurisprudence that one transaction cannot be tied up with another transaction
so as to make the former a pre-condition for the other. Here the transfer of
the asset at the end has been made a necessary condition for the transaction of
lease which is not allowed in Shari‘ah. The original position in Shari‘ah is
that the asset shall be the sole property of the lessor, and after the expiry of the lease period,
the lessor shall be at liberty to take the asset back, or to renew the lease or
to lease it out to another party, or sell it to the lessee or to any other
person. The lessee cannot force him to sell it to him
at a nominal price, nor can such a condition be imposed on the lessor in the
lease agreement. But after the lease period expires, and the lessor wants to
give the asset to the lessee as a gift or to sell it to him, he can do so by
his free will. However, some contemporary scholars, keeping in view the needs
of the Islamic financial institutions have come up with an alternative. They
say that the agreement of ijarah itself should not contain a condition of gift
or sale at the end of the lease period. However, the lessor may enter into a
unilateral promise to sell the leased asset to the lessee at the end of the
lease period. This promise will be binding on the lessor only. The principle,
according to them, is that a unilateral promise to enter into a contract at a
future date is allowed whereby the promisor is bound to fulfil
the promise, but the promisee is not bound to enter into that contract . It
means that he has an option to purchase which he may or may not exercise.
However, if he wants to exercise his option to
purchase, the promisor cannot refuse it because he is bound by his promise.
Therefore, these scholars suggest that the lessor, after entering into the
lease agreement, can sign a separate unilateral promise whereby he undertakes
that if the lessee has paid all the amounts of rentals and wants to purchase
the asset at a specified mutually acceptable price, he will sell the leased asset to him for
that price. Once this promise is signed by the lessor, he is bound to fulfil it
and the lessee may exercise his option to purchase at the end of the period, if
he has fully paid the amounts of rent according to the agreement of lease.
Similarly, it is also allowed by these scholars that, instead of sale, the
lessor signs a separate promise to gift the leased asset to the lessee at the
end of the lease period, subject to his payment of all amounts of rent. This
arrangement is called ‘ijarah wa iqtina’. It has been allowed by a large number
of contemporary scholars and is widely acted upon by the Islamic banks and
financial institutions. The validity of this arrangement is subject to two
basic conditions:
Firstly, the agreement of
ijarah itself should not be subjected to signing this promise of sale or gift
but the promise should he recorded in a separate document.
Secondly, the promise
should be unilateral and binding on the promisor only. It should not be a
bilateral promise binding on both parties because in this case it will be a
full contract effected to a future date which is not allowed in the case of
sale or gift.
10.
SUB-LEASE
If the leased asset is used
differently by different users, the lessee cannot sub-lease the leased asset
except with the express permission of the lessor. If the lessor permits the
lessee for subleasing, he may sub-lease it. If the rent claimed from the sub-lessee
is equal to or less than the rent payable to the owner / original lessor, all
the recognized schools of Islamic jurisprudence are unanimous on the
permissibility of the sub lease. However, the opinions are different in case
the rent charged from the sub-lessee is higher than the rent payable to the
owner. Imam al-Shafi’i and some other scholars allow it and hold that the
sub lessor may enjoy the surplus received from the sub-lessee. This is the
preferred view in the Hanbali school as well. On the other hand. Imam Abu
Hanifah is of the view that the surplus received
from the sub-lessee in this case is not permissible for the sub-lessor to keep
and he will have to give that surplus in charity. However, if the sub-lessor
has developed the leased property by adding
something to it or has rented it in a currency different from the currency in
which he himself pays rent to the owner/the original lessor, he can claim a
higher rent from his sub-lessee and can enjoy the surplus. Although the view of Imam Abu
Hanifah is more precautious which should be acted upon to the best possible
extent, in cases of need the view of Shafi’i and Hanbali schools may be
followed because there is no express prohibition in the Holy Qur’an or in the
Sunnah against the surplus claimed from the lessee. Ibn Qudamah has argued for
the permissibility of surplus on forceful grounds.
11.
ASSIGNING OF THE LEASE
The lessor can sell the
leased property to a third party whereby the relation of lessor and lessee
shall be established between the new owner and the lessee. However, the
assigning of the lease itself (without assigning the ownership in the leased
asset) for a monetary consideration is not permissible. The difference between
the two situations is that in the latter case the ownership of the asset is not
transferred to the assignee, but he becomes entitled to receive the rent of the
asset only. This kind of assignment is allowed in Shari‘ah only where no
monetary consideration is charged from the assignee for this assignment. for example,
a lessor can assign his right to claim rent from the lessee to his son, or to
his friend in the form of a gift. Similarly, he can assign this right to any
one of his creditors to set off his debt out of the rentals received by him.
But if the lessor wants to sell this right for a fixed price, it is not
permissible, because in this case the money (the amount of rentals) is sold for
money which is a transaction subject to the principle of equality. Otherwise it
will be tantamount to a riba transaction, hence prohibited.
SECURITIZATION
OF IJARAH
The arrangement of ijarah
has a good potential of securitization which may help create a secondary market
for the financiers on the basis of ijarah. Since the lessor in ijarah owns the
leased assets, he can sell the asset, in whole or in part, to a third party who
may purchase it and may replace the seller in the rights and obligations of the
lessor with regard to the purchased part of the asset.
Therefore, if the lessor,
after entering into ijarah, wishes to recover his cost of purchase of the asset
with a profit thereon, he can sell the leased asset wholly or partly either to
one party or to a number of individuals. In the latter case, the purchase of a
proportion of the asset by each individual may be evidenced by a certificate
which may be called ‘ijarah certificate’. This certificate will represent the
holder’s proportionate ownership in the leased asset and he will assume the
rights and obligations of the owner/lessor to that extent. Since the asset is already
leased to the lessee, lease will continue with the new owners, each one of the
holders of this certificate will have the right to enjoy a part of the rent
according to his proportion of ownership in the asset. Similarly he will also
assume the obligations of the lessor to the extent of his ownership. Therefore,
in the case of total destruction of the asset, he will suffer the loss to the
extent of his ownership. These certificates, being an evidence of proportionate
ownership in a tangible asset, can be negotiated and traded in freely in the
market and can serve as an instrument easily convertible into cash. Thus they
may help in solving the problems of liquidity management faced by the Islamic
banks and financial institutions.
It should be remembered, however,
that the certificate must represent ownership of an undivided part of the asset
with all its rights and obligations. Misunderstanding this basic concept, some
quarters tried to issue ijarah certificates representing the holder’s right to
claim certain amount of the rental only without assigning to him any kind of
ownership in the asset. It means that the holder of such a certificate has no
relation with the leased asset at all. His only right is to share the rentals
received from the lessee. This type of securitization is not allowed in
Shari‘ah. As explained earlier in this chapter, the rent after being due is a
debt payable by the lessee. The debt or any security representing debt only is
not a negotiable instrument in Shari‘ah, because trading in such an instrument
amounts to trade in money or in monetary obligation which is not allowed,
except on the basis of equality, and if the equality of value is observed while
trading in such instruments, the very purpose of securitization is defeated.
Therefore, this type of ijarah certificates cannot serve the purpose of
creating a secondary market. It is, therefore, necessary that the ijarah
certificates are designed to represent real ownership of the leased assets, and
not only a right to receive rent.
HEAD-LEASE
Another concept developed
in the modern leasing business is that of ‘head-leasing.’ In this arrangement a
lessee sub-leases the property to a number of sub-lessees. Then, he invites
others to participate in his business by making them share the rentals received
by his sub- lessees. For making them participate in receiving rentals, he
charges a specified amount from them. This arrangement is not in accordance
with the principles of Shari‘ah. The reason is obvious. The lessee does not own
the property. He is entitled to benefit from its usufruct only. That usufruct
he has passed on to his sub-lessees by contracting a sub-lease with them. Now
he does not own anything, neither the corpus of the property, nor its usufruct.
What he has is the right to receive rent only.Therefore, he assigns a part of
this right to other persons. It is already explained in detail that this right
cannot be traded in, because it amounts to selling a receivable debt at a
discount which is one of the forms of riba prohibited by the Holy Qur’an and
Sunnah. Therefore, this concept is not acceptable. These are some basic
features of the ‘financial lease’ which are not in conformity with the dictates
of Shari‘ah. While using the lease as an Islamic mode of finance, these shortcomings
must be avoided.
The list of the possible
shortcomings in the lease agreement is not restricted to what has been
mentioned above, but only the basic errors found in different agreements have
been pointed out, and the basic principles of Islamic leasing have been
summarized. An Islamic lease agreement must conform to all of them.
Ijarah means lease, rent or
wage. Generally, the Ijarah concept refers to selling the benefit of use or
service for a fixed price or wage. Under this concept, the Bank makes available
to the customer the use of service of assets / equipments such as plant, office
automation, motor vehicle for a fixed period and price.
A contract under which an
Islamic bank provides equipment, building, or other assets to the client
against an agreed rental together with a unilateral undertaking by the bank or
the client that at the end of the lease period, the ownership in the asset
would be transferred to the lessee. The rentals as well as the purchase price
are fixed in such manner that the bank gets back its principal sum along with
profit over the period of lease.
No rental will be due if
the lessor fails to deliver the asset to the lessee on the date specified in
the ijarah contract. At the end of the ijarah agreements the lessee has
one of three options; either to return the leased asset to the lessor or to
renew the lease contract for another term or to purchase the leased asset for a
price that is determined based on rental payments made by the lessee.
IJARAH MUNTahia - bi -
tamleek
In the Islamic
jurisprudence, one transaction cannot be conditioned by another transaction.
Ijarah and sale/purchase transactions are two different contracts and the
transfer of ownership in the leased property cannot be made by a sale contract
on a future date along with the Ijarah contract. Therefore a ‘Hire-Purchase’
agreement which combines both lease and sale at the time of contract, it is not
suitable for Islamic banks.
The method acceptable to
Shari´ah is that the ownership remains with the lessor along with all
liabilities emerging from ownership. As a result, Islamic banks take the asset
risk, bear the ownership related expenses and give or take responsibility for
transfer of the asset to the lessee upon termination of the lease. This is done
under Ijarah Muntahia-bi-tamleek which includes a promise by the lessor to
transfer the ownership of the leased property to the lessee. The transaction
basically remains that of Ijarah and the transfer of ownership is kept separate
from the main Ijarah contract. Under this arrangement, the bank purchases the
asset for the client who then leases the asset from the bank; at the end of the
lease term, the transfer of the asset ownership to the lessee is kept separate.
Ijarah shares many common
features with financial lease and hire-purchase arrangements. It involves a
lessor purchasing an asset and renting it to a lessee for a specific time
period at an agreed rental and at the end of the lease period transferring the
ownership of the asset to the lessee. However, Ijarah Muntahia-bi-tamleek is
different from the conventional leases where the rentals start accruing as soon
as the payment for purchase of the asset being leased is made by the lessor;
while in Ijarah Muntahia-bi-tamleek, rentals start at the time when the asset
is supplied to the lessee in useable form. Also, if the price of the asset is
paid to the lessee instead of the supplier, there must be an agency (Wakalah)
agreement between the parties prior to the lease agreement that gives authority
to the lessee to purchase the asset on behalf of the bank. If the asset is
destroyed before its delivery to the lessee in useable form, the loss will be
that of the bank and not of the agent. Therefore, the risk of the asset will be
that of the bank as long as the client serves as its agent for purchase of the
asset while in conventional lease all risks are borne by the lessee.
In addition, is different
from a hire purchase and finance lease in the sense that it is an arrangement
that does not comprise two contracts in one bargain; in fact, leasing is the
real and the major contract; therefore, it is subject to all Shari´ah rules of
an ordinary operating Ijarah contract. The transfer of ownership is processed
through a separate sale or gift contract. This other part of the deal is only a
unilateral promise not binding on the promissee and as such it is not a
transaction until actually entered into by the parties. In addition, Ijarah
Muntahia-bi-tamleek is a fair arrangement based on justice for both the
parties; the lessor recovers cost of the leased asset and also the profit in
the form of rentals while the lessee can get ownership title of the asset at
the end of the lease period. The lessee is also protected from the loss by the
lessor would bear all responsibility for loss of the leased asset, in case of
absence of negligence on the part of the lessee.
Potential of Ijarah
- There are many Islamic finance structures where
Ijarah can be used. Islamic banks use this mode of financing with the
purpose of enabling customers to use durable goods and equipment such as
ships, housing, heavy machines and plants in productive enterprises who
may be unable to buy them for their production purposes.
- Ijarah has also huge potential as a financing
mode for retail, corporate and the public sectors and can also play a
crucial role in promoting Islamic finance industry. It can be used as
incentive to economic development as it is usually long term and offers
potential for stimulating productive industries.
- Leasing is an attractive mode of investment for
Islamic banks because assets acquired under these contracts are usually of
high quality, marketable and maintain their market value well above book
value; therefore, the bank does not have to depend so much on the
creditworthiness of the lessee, given that as a recourse, it can sell the
asset to dispose for cash in case of default. And since the Islamic bank
acquires the desired asset only when a client requests it and commits
himself to enter into a lease contract with the bank, the possibility of
misuse of funds and assets is minimized and the bank can make a profit by
setting the rent at a level that covers, over the lease period, the
purchase price as well as a return in line with the current rate of
mark-up. In fact, Islamic banks can get variable and floating return on
long term investments. And although Ijarah is a longer-term financing
instrument, a leasing contract can be reviewed periodically. The financing
party thus not tied down to a fixed return that may not be in its
investment goals.
- Furthermore, Ijarah offers the advantage of not
requiring collateral and thus of simpler repossession procedures since
ownership of the asset lies with the lessor. It also means that it has
greater in-built stability to contain inflationary pressures in the
economy. The lessor is only exposed to a low level credit risk from the
lessee as the lease transaction is, by definition, asset-backed. Ijarah
has also become popular due to a tax advantages as the rental can be
offset against corporate tax by the lessee.
- Finally, Ijarah can be used indirectly for Sukuk
issues by the corporate and the government sectors. Ijarah Sukuk represent
leased assets without actually relating the holders to any corporate body
or institution. Securitisation on the basis of Ijarah is an alternative
tool to interest based borrowing provided it uses durable and useable
assets. For example, an aircraft leased to an airline can be represented
in bonds and owned by a number of Sukuk holders, each of them individually
and independently collecting their periodic rent from the airline company.
The Sukuk holders are not owners of a share in a company that owns the
leased asset, but simply a sharing owner of a part of the aircraft
itself. Islamic banks are also able to offer leasing certificates
to their depositor clients as specific investment certificates as a form
of declining equity. These mechanisms facilitate the formation of fixed
assets and can contribute to long term economically beneficial investment.
Valid lease
- The first conditions required in a valid Ijarah
are that the two sides of the exchange must both be known and specified in
such a way that eliminates the possibility of disagreement and dispute;
that the usufruct in question has a financial or market value; The assets
from which it is almost impossible to derive any benefit from its use,
cannot become the subject of Ijarah; and also the agreement does not
involve unlawful activities and substances. The contracted usufruct and
the rent should be ascertained clearly and agreed in advance, either for
the full period of the lease or for a specified period in absolute terms.
- Since leasing is a variety of sale, it is lawful
in everything that can lawfully be bought and sold, and the rules of
Shari´ah pertaining to sale are also generally applicable to leasing. In
fact, any Islamic financing mode should be asset-based there has to be an
element of risk taking. In fact, the profit is generated when an asset
having intrinsic utility is sold or offered for use; and one cannot claim
a profit without bearing the risk connected to the transaction. Therefore,
most of the rules relating to the contract of sale come into existence
also apply to Ijarah or Islamic leasing. Muslim jurists have,
however, singled out some conditions the validity of an Ijarah contract
with respect to the asset or service hired and the rental.
- Since leasing transfers the ownership of usufruct
from the lessor to the lessee, the former must not only own the assets
involved but also be able to transfer the ownership of its benefits to the
lessee. If a particular asset is specified for Ijarah, the
lease contract cannot be executed before getting of the asset or its
usufruct. It is also a requirement of a valid Ijarah that the lease period
must be specified and that the lessor retains ownership of the leased
asset during the entire period of the lease. Liabilities arising from
ownership will be borne by the lessor, while the liabilities relating to
the use of the property leased asset will be borne by the lessee. The
lessee is liable for any loss to the leased asset due to negligence, but
he cannot be made liable for loss caused by factors beyond its control.
- The rental can be determined, with the mutual
consent of the contracting parties, on the basis of aggregate of the cost
incurred by the lessor for the acquisition of the assets to be leased and
based on a reasonable rate of return by reference to an agreed benchmark.
If the lease is based on a floating rental rate, it is recommended to use
a well known benchmark or index to determine rentals of subsequent periods
in a long-term lease to avoid any dispute or injustice due to possible
fluctuations in the market rate structure and binding nature of the lease
contract. The floating rate, however, should be subjected to an upper
limit in order to avoid the element of Gharar.
- Furthermore, a stipulation may be inserted in the
Ijarah contract making late payment by the lessee over a period of time
liable to a certain amount of charity. This may provide prevention
from late payment even though it does not compensate the lessor for his
opportunity cost over the period of default. The lessor may also approach
a competent court to award damages for any shortfall. The lessor can also
demand payment of an earnest money amount as advance payment of rentals to
ensure that the prospective lessee fulfils the commitment to take
possession of the asset on lease when purchased by the lessor. If the
Ijarah contract is not executed for any reason attributable to the lessee,
the lessor can recover from the earnest money the amount of the actual
losses suffered loss incurred in this agreement. And unlike normal sale
which cannot be effected for a future date, Ijarah for a future date is
permissible. The lease period and the lessor’s entitlement to rent,
however, begin form the date on which the leased asset has been delivered
to the lessee. The rent thereof may be payable in advance before delivery
of the asset to the lessee. Any advance rentals must be adjusted against
future rentals.
- Finally, either the lessor or the lessee can make
a unilateral promise to buy or sell the leased asset at the end of the
lease period, or earlier, at an agreed price, provided that the lease
agreement shall not be conditional upon such sale. On the other hand, the
lessor may make a promise to gift the asset to the lessee upon termination
of the lease, provided the lessee has fulfilled all the obligations under
the contract. There must also not be any stipulation in the contract
purporting to transfer of ownership of the leased assets at a future date.
Sources:
Ethica, Handbook of Islamic Finance 2017 edition
