The last article dealt with the situation of the total destruction of the leased asset under a forward lease contract.
I hope that pursuant to the explanation, readers will now appreciate that, unlike the termination of an ordinary lease contract upon the occurrence of total loss of the leased asset, the destruction of the leased asset under a forward lease contract does not warrant the termination of the forward lease contract.
To refresh, the leased asset under a forward lease contract is not readily available but rather it is known through the description it would hold once it comes into being. As such, in case of the total annihilation of such an asset, the lease contract shall remain intact but the rent shall be paused until such time that the lessor arranges an alternate asset of a similar description. In fact, it is the right of the lessee to demand from the lessor to provide a new asset with the same description as entered into in the forward lease contract.
We left a question in article 77 which now needs to be addressed. It was with regards to the nature of a forward lease contract being a financial lease whereby the lessee shall acquire the title to the leased asset upon the successful culmination of the contract — what shall be the lessee’s situation if the asset gets totally destroyed in the middle of the lease term and the lessor is unable to provide a replacement asset with similar specifications in order to resume the lease and the lessor requests the lessee to agree to terminate the forward lease contract?
Well, in the case of destruction of the leased asset due to the lessee’s negligence, Shariah principles stipulate that the lessee shall be responsible to procure the alternate asset with similar specifications, request the lessor to inspect the asset and acquire the title so as to resume the lease.
It will be at the discretion of the lessor if it would like to seek compensation for the lost profit, ie variable element of the lease rentals from the lessee for the period of the interruption of the lease rent. If the lessee is unable to provide the alternate asset, it will be responsible to compensate the lessor for the outstanding fixed element amount related to the lost asset in the lessor’s books.
However, if the asset under a forward lease contract gets destroyed without the lessee’s negligence and the lessor fails to provide the alternate asset to resume the lease and seek the lessee’s consent to terminate the forward lease contract, the lessor shall return the amount it has collected so far on account of the fixed element from the lessee. It is therefore emphasized by the Shariah supervisory board of Islamic financial institutions to invariably obtain Takaful cover for any asset the ownership of which is held by an Islamic financial institution. In such cases, the Islamic financial institutions shall be able to mitigate the risk of loss to the leased asset through Takaful.
It provides a win-win situation for both parties whereby the lessee enjoyed the asset until the destruction date for which he paid the variable element of the lease rent, the lessee holds the right to demand the alternate asset with similar specifications, the lessee is adequately compensated for the fixed element it paid from the lease commencement until destruction in case of the lessor’s failure to provide the alternate asset and the lessor took shelter from the Takaful policy in the situation where it is obliged to refund the fixed element to the lessee.
Another aspect I would like to discuss on Ijarah is that it is a fairly robust product from the risk perspective as a lessor for an Islamic financial institution. If an Islamic financial institution grants the financial lease facility to a customer over a movable or immovable asset at a 20% or 30% margin, from day one, the Islamic financial institution shall hold the 100% title to the leased asset whereas its financing shall be restricted to 70% or 80%.
As the lease gradually progresses toward the completion date, the lessor’s title over the leased asset shall remain fixed at 100% whereas the finance it has provided shall continue to get reduced with every lease rent payment, thereby strengthening the Islamic financial institution’s security position over the leased asset. In addition, the Islamic financial institution’s security position is further enhanced if it is a real estate asset whose market price registers an increase.
As such, in the case of default in the payment of the lease rent by the lessee, being the lessor, the Islamic financial institution shall have the right to terminate the lease contract, get the lessee evicted, repossess the leased asset and re-lease it to someone else, or dispose of it in the market. Wouldn’t you do the same if you own an apartment and your lessee fails to pay the agreed lease rent?
Great, so it is proved beyond doubt that the financial lease product is the most advantageous proposition for an Islamic financial institution.
Ok, but hang on — if the lessor gets the lessee evicted in the middle of a financial lease transaction due to non-payment, what happens to the amount of fixed element the lessee paid in anticipation of getting the title to the leased asset transferred to it upon completion of the lease term?
I think the lessee shall be the last person on earth to even think of committing a payment default?
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the senior advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected]
Next week: We shall continue with our discussion on the last few points on Ijarah.