I hope my description of the hybrid Musharakah–Ijarah structure is clear to readers.
The message from the explanation is that there should be no need to opt merely for the form in the shape of a commodity Murabahah–Mudarabah structure when the form and substance both are available through the genuine combination of Musharakah–Ijarah contracts which shall achieve the same objectives. Please write to me should you need any clarification.
Now, what happens if the customer is unable to comply with the financial lease terms and as a result, there is a default? Remember, I am writing this article in the series about the Islamic capital market and am assuming the default has happened in the hybrid Sukuk Musharakah–Ijarah.
I have discussed the Ijarah Muntahiya Bil Tamleek (IMBT) default situation in the Ijarah articles with clarity but here the circumstances are different. This is the hybrid structure we are dealing with and not a single Ijarah transaction.
If the lessee (originator of Sukuk) in terms of the IMBT fails to pay the Ijarah installment on time, a notice shall be served by the lessor (trustee shell company representing the Sukuk investors) to remind the lessee and in the event of no remedial action taken by the lessee, the lessor shall have two options.
These are as follows:
First option: the lessor shall decide to terminate the lease by utilizing the put option in terms of the purchase undertaking accorded to it by the lessee at the time of entering into the lease agreement.
The exercise notice served by the delegate (representing the trustee shell company) to the lessee shall demand the following amounts (the exercise price) upon payment of which the Musharakah agreement between the parties shall also stand terminated:
• The accrued and unpaid variable element of the lease rent representing the profit for the Sukuk investors
• The balance of the fixed element remaining to be paid, demonstrating the unredeemed part of the investors’ equity, and
• The lessor’s share of the major maintenance cost for the leased asset if borne by the lessor and not added to previously paid rent.
Second option: The lessor shall decide to terminate the lease but continues with the Musharakah agreement. In this situation, the lessor shall not serve the exercise notice and shall terminate the lease with mutual consent by amicably entering into the lease termination agreement.
In other words, the erstwhile lessor and the ex-lessee shall assume the role of active partners to manage the Musharakah affairs jointly and distribute the profit as per the agreed sharing ratio, or bear the losses pro rata.
What happens to the fixed element paid by the ex-lessee until the lease termination date? Well, the amount shall be adjusted in the Musharakah equity in a manner that the obligor’s equity shall rise at the cost of the Sukukholders’ share, which shall correspondingly reduce.
As for redemption of the remaining amount of Sukukholders’ equity, the partners may enter into an addendum to the Musharakah agreement with a redemption timeline which should coincide with the fixed element payment schedule in the now-terminated lease agreement. Alternatively, the remaining equity may also be redeemed by way of a bullet payment at the maturity of the Sukuk.
The following points should be noted in case the second option is adopted:
1. The decision to opt for the second option should be pre-advised in the Sukuk prospectus in the risk area. If this is not the case, the preferred option shall be decided by the majority of the Sukuk investors — majority being the Sukuk investment amount and not the number of investors.
2. The hybrid Sukuk Musharakah–Ijarah shall transform into a single Sukuk Musharakah from the date of termination of the lease agreement.
3. By virtue of assuming the role of an active Musharakah partner pursuant to the termination of the lease agreement, the Sukuk investors shall stand exposed to the operation, performance/market and the rate of return risks for the remainder of the Sukuk tenor, which were successfully mitigated through the lease agreement.
4. As for the ownership risk in the Musharakah asset, this will remain to the extent of the outstanding amount of the Sukukholders’ equity until full redemption.
In the next article, I will try to wrap up the last few points on the Islamic capital market before taking on the new subject of Islamic asset management.
So, you have a last chance to throw questions at me.
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: Wrap-up discussion on Sukuk transactions shall continue.