Welcome back after the Eid Al Adha break. I will try to conclude the topic of a purchase and leaseback transaction in this article.
In the last article (Article 66), we were in the middle of discussing how an Islamic bank assists a business toward meeting its cash needs by way of entering into a purchase and leaseback of an asset owned by the customer. Such liquidity needs could either be utilized to expand the trading activity, payment of trade and other debts, or the expansion of an industrial plant and such.
The modus operandi of a purchase and leaseback transaction was covered in the last article and we need to address the question of the cost effectiveness of the transaction vis-a-vis the conventional bank’s term loan, given the land registry fee and the other relevant charges expected to be incurred by the Islamic bank upon assuming the ownership of the customer’s asset.
The Shariah scholars’ position is clear in such transactions whereby it is considered adequate if the Islamic bank and customer sign the asset sale and purchase agreement where the Islamic bank is the buyer and the customer is the seller, without requiring the customer to transfer the legal title to the Islamic bank. This is because as per Shariah, the ownership of the asset gets transferred to the buyer based on the signed sale and purchase contract.
Readers shall recall the discussion which took place in this space about the emergence of the land registry function sometime in the 19th century from the UK. Until that time, there was no such requirement in the world but the sale and purchase of real estate was being carried out freely.
In other words, as such, pursuant to signing the sale and purchase agreement between the parties, the customer will continue to hold the registered title as before — not in the Shariah capacity as the owner but as the title trustee.
What does title trustee mean? The title trustee is a person or an entity which holds the legal title of an asset for and on behalf of another person or entity, or in simple terms, on behalf of the de facto owner.
How does a trustee assume such responsibility? The parties sign a document called ‘deed of trust’ or ‘trust deed’ which is an agreement between the principal (the de facto owner) and another person or entity holding the registered title to the property, who assumes the responsibility as the trustee. Such a deed is executed under the trust laws of the relevant jurisdiction.
However, based on my own experience, I have noted that not all countries have promulgated the trust law which is mostly found in the offshore financial centers such as Cayman Islands, Jersey. etc. However, almost all countries in the world do have the agency law and these include countries practicing common law or civil law.
The difference between the two sets of law is that common law is based on precedents whereas civil law is codified statutes. As per careful assessment, about 150 countries follow civil law and almost 80 have preferred to work on a common law basis and then there are countries which have a mix of both sets of law, and that explains the total number of countries reaching 230 whereas the actual number of countries accommodated by the Earth so far is 195 or 197.
The UAE works under a civil law regime whereas Malaysia mainly has a common law-based legal system. Both sets of law undergo updating from time to time in the relevant jurisdiction based on developments, or the need to address a new situation. And then there is Shariah law which is based on divine guidance with the principles etched in stone.
The important aspect for readers to appreciate is that the agency agreement is equally accepted in all sets of legal systems, ie common, civil or Shariah law. As such, irrespective of the nature of the law, party A can appoint party B to undertake a certain task as an agent of party A, including being the title agent.
Going back to the subject of a purchase and leaseback transaction, the Islamic bank appoints the customer (who is also the seller of the real estate asset under the sale and purchase agreement) as its title agent in jurisdictions where the trust law does not exist.
The title agency agreement contains a clause which states that should the principal require the agent to complete the formalities to transfer the registered title to the principal, the agent shall cooperate and comply without fail. Such a clause protects the Islamic bank in a default situation when the Islamic bank would like to sell the asset in the market so as to recover its investment.
At this juncture, the Islamic bank shall need to pay the land registry fee and the other charges to become the registered owner before it is legally empowered to trade in the leased asset.
Some Islamic banks have come up with double safety measures whereby they seek a mortgage over the asset as part of the purchase and leaseback transaction. Such a mortgage is released upon the Islamic bank assuming the ownership of the asset in a default situation, or upon the successful completion of the lease agreement.
As such, an Islamic bank can provide the required liquidity to a customer in need through a purchase and leaseback transaction without incurring any additional costs to the customer vis-a-vis a conventional bank’s term loan.
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 of the other aspects of Ijarah shall continue.