As promised, this week I will explain the utilization of an Ijarah contract in the transactions formally known as ‘purchase and leaseback’. Such transactions are applied to provide liquidity relief to customers in need through a Shariah compliant mechanism.
The first and foremost aspect to know in this respect is that this type of transaction is not the norm in the consumer banking segment of an Islamic bank but is frequently used in the wholesale banking section where liquidity is a daily challenge for corporate customers.
The next thing to know is whether the customer owns any clean-titled movable or immovable asset. By clean-titled, I mean it must not be charged or ‘liened’ or mortgaged to any conventional lender or Islamic financier or any third party for that matter.
Also, at times the corporate entities obtain certain credit facilities and provide a negative pledge as a covenant. The negative pledge clause in the credit facility documentation is inserted to prevent a customer from pledging any assets in a way that compromises the lender’s existing security position.
If such a clause appears in an already executed credit facility agreement or documentation between the corporate entity and a bank or financial institution (or a consortium of banks or financial institutions), the entity shall not be able to offer any of its assets to the Islamic bank or financial institution for undertaking a purchase and leaseback transaction even if there is no formal or registered charge on them, unless the corporate entity officials are able to obtain a no-objection from all of the existing lenders/financiers enjoying the negative pledge. In such a situation, the existing banks may allow a one-time exemption.
Then comes the juncture of ascertaining the funding need of the client vis-a-vis the current value of the offered asset. The value could be determined in various ways including relying on the value of the offered asset appearing in the latest audited balance sheet after taking into consideration the depreciation for the period from the last audited balance sheet and the time of the application.
Another approach could be to seek professional valuation of the asset, carried out by a reputable surveyor. However, depending on the Islamic bank’s level of trust on the customer, there may be no need to obtain independent valuation and it should be in order to rely on the amount appearing in the entity’s latest audited or in-house financials. This is purely a commercial decision and not a Shariah requirement. The Shariah principle is that both parties must agree to the value of the asset being traded.
Now we shall have a look at immovable property, such as buildings, factory premises or commercial real estate. While the residential units are considered fully Shariah compliant, there may be an issue with the Islamic bank accepting the immovable office or commercial property for the purpose of a purchase and leaseback transaction if the activities of some of the tenants are classified as non-Shariah compliant, such as conventional banks, conventional insurance companies and outlets selling pork, wine and tobacco.
I remember in one such situation that I had handled in past, the property offered for an Islamic real estate fund was located in a European country. Part of the property was occupied for residential purposes and the rest for offices with the ground floor having shops. The scholars forming the Shariah board of the institution I was assisting first thoroughly reviewed the situation based on the documents provided and came up with the solution to carve out the non-Shariah compliant units from the overall property block and conduct the transaction based on the available units not violating any Shariah principles. The guidance provided by the Shariah scholars reduced the amount of the transaction, albeit no compromise was made on the Shariah principles.
Similarly, the same principle shall be applied if the offered property holds some units where Shariah-repugnant activities are carried out. Moving on, the Islamic bank shall purchase the customer’s fully Shariah compliant property by way of signing the property purchase agreement by virtue of which the ownership to the property shall get transferred to the Islamic bank, empowering it to lease the property to the corporate entity. The lease agreement shall be entered into between the Islamic bank as the owner and the corporate entity as the lessee.
We have discussed in previous articles about the concept of ownership and possession in Shariah. As such, when the Islamic bank signs the property purchase agreement, it assumes the ownership of the property from the customer and is now able to lease it to the customer.
A question arises whether the transaction remains cost-efficient for the customer compared to conventional bank lending after taking into consideration the land registry fee and the other relevant charges upon the bank assuming ownership. I would like to leave the explanation and discussion to next week’s article.
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: Discussion on purchase and leaseback and other aspects of Ijarah shall continue.