In this article, UMIT AKKAYA intends to assess, from a legal perspective in the context of the provisions of the applicable legislation, the criticisms over the transfer of title to and pledge of the underlying assets in Sukuk practices in Turkey.
Lease certificates (Sukuk) are pretty new financial instruments first introduced in the financial/economic life of Turkey in 2010. A lease certificate is defined in Article 61/1 of the Capital Markets Law No. 6362 and Article 3/1 of the Lease Certificates Communiqué (III-61.1) as follows: “Lease certificates are capital market instruments the qualities of which are determined by the Board and issued by asset-leasing companies for the purpose of providing the financing of all kinds of assets or rights and securing that their owners obtain a right from the generated incomes in proportion of their shares.”
Taking into account all the definitions and classifications, the ‘Sukuk’ term is apparently a financial legal institution in reference to the purpose of ‘providing finance’, and it is required not to disregard that raison d’etre of the Sukuk in making assessments and criticisms over this matter.
In this respect, our assessments over the title transfer and pledge issue, as one of the basic matters criticized and cited in Sukuk practices in Turkey (arguments that the asset or right has not been permanently and absolutely disposed of and that the power of disposition over the asset/right has been restricted by law, etc) are summarized in the following.
AAOIFI states that: “Sukuk, to be tradable, must be owned by Sukukholders, with all rights and obligations of ownership, in real assets, whether tangible, usufructs or services, capable of being owned and sold legally as well as in accordance with the rules of Shariah, in accordance with Articles (2)1 and (5/1/2)2 of the AAOIFI Shariah Standard (17) on Investment Sukuk”.
Transfer of ownership
In terms of applicable legislation in Turkey, the Sukuk-related asset/right is transferred to the asset-leasing company (ALC) in accordance with the applicable law (Article 5/2 of the Communiqué Nob 61.1.III) and is kept in custody by the ALC for and on behalf of the investors unlit the same is redeemed (Article 61/3 of Law No. 6362). Therefore, the investors own the said asset/right perfectly and without any restrictions. The ownership right of the investors is willingly restricted under buy-back agreements executed by the parties and during the effectiveness of the buy-back right. Such a buy-back right is among the limited rights in rem as per our legislation and grants the rightholder to buy back the underlying asset within the period of time defined in the contract (not exceeding 10 years) (Article 736 of Turkish Civil Code). If the rightholder fails to exercise its buy-back right within such a period, the ownership becomes unlimited again and the owner (ie the ALC acting on behalf of investors) becomes entitled to enjoy a complete discretion over the asset/right.
At this point, in our opinion, it would be legally appropriate to consider the type of ownership the investors acquire over the asset/right as ‘co-ownership’ in accordance with Article 701 of Turkish Civil Code because in this case, a group came together to acquire the Sukuk to be issued (ie investors) and these investors have combined their capital in order to purchase (acquire) the asset/right to be issued and to derive income therefrom. It is quite possible the group so gathering together can also be considered as an ordinary partnership. As a matter of fact; Article 620 of the Turkish Code of Obligations reads: “Ordinary partnership agreement is a contract whereby two or more persons undertake to combine their labor and goods to reach a common goal. If a partnership does not have the distinctive qualifications of partnerships as regulated by law, such partnership is considered as one subject to the provisions of this section”.
At this point, while the ordinary partnership is not a perfect qualification, it would be required to qualify that group as an ordinary partnership. Therefore, with reference to the provisions of Article 638/1 of the Turkish Code of Obligations which reads: “Goods, receivables and rights in rem which have been acquired for or transferred to the partnership belong to all the partners as the co-owners under the partnership agreement”, it would be appropriate to say that the investors are the co-owners of the underlying asset/right.
Islamic scholars reviewing the problems related to the title transfer and buy-back in the case of Sukuk transactions have dealt with that matter within the scope of Bai Al-Wafa (Bai Bi-l-Istiglal). Bai Al-Wafa has been defined as a sales contract with the condition that, “when the seller pays back the price of the property sold, the buyer returns the property to the seller”.
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Pledge
In some debates and assessments, there is criticism that such sales/title transfers must be considered as a pledge/security, but such hypothetical criticism is not acceptable at all due to the pledge right is of a secondary nature and it merely grants the rightholder (creditor) the right to claim the foreclosure of the pledge. Again, the rightholder (creditor) is obliged to refund to the pledgor (debtor) any sum that remains after the former has foreclosed the pledge and collected the amount owed to him and if the foreclosed sum is not sufficient to cover its receivable sum, the deficient portion can be claimed from the debtor.
Finally, the rule that states: “Any pledge agreement providing for the transfer of the title to the pledged movable asset to the creditor in case of failure to honor the debt is void and invalid” is known as the most fundamental principle and distinctive element of the pledge law where the creditor is not entitled to seize the pledged asset (lex commissoria prohibition). There is no such thing in the case of assets/rights transferred to investors by way of Sukuk where any profit/loss resulting from the foreclosure belongs to the investors because the ownership right (except for the limited right in rem that is granted to the rightholder, for a limited period of time, with the buy-back guarantee) is not subject to any restrictions.
In our opinion, one solution for this problem is any assessment must be made by considering the following particulars with respect to legislation and contractual relationships: In the case where the buy-back right is not or cannot be exercised, i) is the right of the buyer (investors) to acquire the asset/right being the subject of the issuance prohibited?; ii) is the sum in excess if the buyer forecloses the asset/right refunded to the seller (originator)?; iii) if the foreclosed sum is not sufficient to cover its receivable sum, is it possible to claim the deficient portion from the seller’s (originator’s) assets (guarantees)? If the answer is ‘yes’ to these questions, then such a relationship must indisputably be subject to the provisions of the pledge. If the answer is ‘no’ to these questions, then the provisions of the pledge cannot be applied, and the dispute is required to be settled by applying the sales terms.
It is observed in the practice that the buy-back right is exercised with the promise of the seller (originator) in the form of an ‘acquisition undertaking or ‘buy-back undertaking’ which is, in our opinion, a fault (unlawfulness) that must be corrected because the ‘buy-back undertaking’ and ‘buy-back right agreement’ are not the same thing and as such, they do not give rise to the same effects. With respect to this problem, we believe that Sukuk are a more developed legal institution than the Bai Al-Wafa (Bai Bi-l-Istiglal) contracts with regards to Islamic law and applicable legislation in that the Sukuk perform the title transfer and sales agreements flawlessly.
Given the foregoing basic problems, we can conclude that it is regrettable that Sukuk, being indisputably one of the most important instruments of interest-free finance and a pretty new product in our country’s practice, suffer extremely tough and fierce criticisms, whether rightful or not. More constructive and improving criticism (especially by Islamic jurists) would favorably contribute to the establishment of a sound and healthy interest-free finance structure.
Umit Akkaya is a partner at law firm Mutlu Avukatlik Ortakligi. He can be contacted at [email protected].