In the last article, I had written about the Shariah compliant mechanism for dealing with major maintenance of the Sukuk Ijarah asset and how the lessor can delegate this responsibility to the lessee as its agent but at the lessor’s cost.
I had concluded the article with a question that, what if the servicing agent does carry out the major maintenance of the leased asset but does not submit the claim for reimbursement to the principal (lessor) under the servicing agency agreement? Let me explain the practical aspect of such situation.
Going back to many Sukuk and consortium transactions besides large-scale bilateral and club deals dealt by me based on an Ijarah structure, I never found any servicing agent in any transaction ever claiming any major maintenance amount which may have been spent by it, on the lessor’s behalf, in keeping the asset in top working condition. As such, there was no incident of adding a supplementary element in the periodic rental for the transactions that I had closed.
If that was the case, the question arises as to how the Ijarah asset continued to function in excellent working condition throughout the lease term if no major maintenance was ever carried out, especially for technical assets such as aircraft, marine vessels, industrial plants, etc. Let me explain.
The fact is that an airline continued to get the aircraft engine overhauled, a marine vessel was regularly dry-docked and an industrial plant was taken good care of as per the manual and standard operating procedures, and all of it was religiously carried out by the lessee party at its own cost, who was also acting as the servicing agent. What was missing from the start until the end of the lease term was the agent’s invoice to the principal for reimbursement in terms of the servicing agency agreement.
A point to ponder is if that was the case, why did the lessor (in the capacity as the principal), never reminded the lessee (as the servicing agent), to submit the invoice to claim the amount spent by it on major maintenance of the leased asset? This intriguing question was posed to the relevant scholars who seemed to have all the knowledge in the world, and you will find their reply interesting, as well as convincing.
They said that the lessee, acting as the servicing agent, has been provided with full protection in the servicing agency agreement to submit the documentary proof of the amount spent by it toward maintenance of the asset to the principal (lessor).
However, if the lessee voluntarily decides to bear the cost of major maintenance by not submitting the reimbursement claim to the lessor, there is no Shariah compulsion on it to do so.
But if the agent (lessee) is found to be negligent in fulfilling its responsibility for carrying out major maintenance, and as a result damage is caused to the leased asset, the lessee/agent shall be held fully responsible in terms of the servicing agency agreement — as well as the lease agreement — to restore the leased asset to the full working condition at its own cost, or to compensate the lessor adequately.
Also, since the lessee/agent has caused the damage to the leased asset, the Shariah principles do not allow the continuation of the lease over a defective asset, hence any loss to the lessor on account of rental disruption shall also be borne by the lessee/agent. Fair approach, isn’t it?
Pursuant to clarity of guidance, I also figured out that the lessee in Sukuk Ijarah is not losing anything in financial terms by not claiming the amount spent by it on major maintenance. This is because in any case the lessor has the right to reclaim the amount reimbursed by it, through the supplementary element of periodic rent, and if the principal/lessor did not receive any claim from the agent/lessee, it will also not add the amount through a supplementary element in the periodic rental.
This led me to believe that there is always a silent set-off between the servicing agent and the lessor related to the major maintenance cost, and that it did not raise the eyebrows of the scholars approving the Sukuk Ijarah documentation.
Nevertheless, during the entire course of both agreements, the agent/lessee will always have the right to reclaim such costs and, as the balancing act, the lessor will hold the right to utilize the supplementary rental.
There is another solution to the whole saga which is for the lessor to seek quotations from qualified third parties for keeping the Sukuk Ijarah asset in the desired working condition throughout the Sukuk term and appoint the most competent party as its agent for carrying out the required major maintenance with an agreed periodic payment.
On the other hand, the lessor, having known the major maintenance cost beforehand, may add the relevant amount to the rental. Upon receipt of the rental from the lessee, the lessor shall take out the amount due to be paid to the maintenance agent and retain the balance for distribution to the Sukukholders.
However, it requires additional care, effort and responsibility which the stakeholders of a Sukuk Ijarah transaction are not prepared to undertake. Not as yet I believe.
The purpose of this educative series and the article is not to hurt any religious or commercial sentiments either consciously or even unwittingly.
Sohail Zubairi is an Islamic finance specialist and AAOIFI-certified Shariah advisor and auditor. He can be contacted at [email protected].
Next week: Discussion on the Sukuk procedures shall continue.