This week is the start of the explanation of a new subject which is the fourth Shariah sales contract Islamic banks and financial institutions use for various product offerings. This is called Aqd Al Ijar or Ijarah or the agreement to lease.
Leasing is common in the conventional and Islamic financial systems albeit with vast differences in its applications — similar to the differences we have learned between Islamic and conventional banks.
First of all, why would the act of leasing be categorized as a sales contract despite ofno asset or commodity is being bought and sold? That is correct. However, do note that under a lease agreement, the subject matter is the usufruct or right to use an asset for a defined period of time and not the asset itself.
In a recent article on Istisnah, I had explained the definition of usufruct which is the right to enjoy the usage and taking advantage of someone else’s property for an agreed period of time at a cost, in a manner that it remains intact at the end of the period.
Putting it in another manner, a lease agreement is the sale and purchase of the usufruct for a certain defined period of time. A question then arises: is the usufruct a commodity that can be bought and sold through an Ijarah agreement? The answer is yes. The Shariah approach is clear that the usufruct fulfills the Shariah criteria of being a commodity and hence it can be freely bought and sold.
Nevertheless, this kind of sales contract is different in that there is a time limitation (lease tenor) which is not found in Murabahah, Salam or Istisnah sales contracts which we have discussed exhaustively.
Another refresher for readers is that Shariah recognizes different kinds of ownership. It was discussed at length in this space that the ownership in Shariah can be classified as three kinds. The first kind is complete ownership where the title and possession to a movable or immovable property both are held by a single party (a person or a group of people or an entity).
The second kind is incomplete ownership where the title to a property is held with one party but without possession and the third kind is where possession is owned by a party but without the title. All of them are permissible in Shariah and are used for different transactional purposes.
Since the act of leasing is captured under a contract, all parameters of the Shariah contract, explained earlier in this space, must apply to leasing, including a minimum of two parties, offer and acceptance, contract language being Shariah compliant, delivery of usufruct, payment of agreed leasing price (rent) and the purchaser of the usufruct (lessee) extracting the benefit from the leased asset.
Once entered, the lease contract is binding on both parties and cannot be revoked unilaterally nor can the terms of the lease contract be altered. However, any element of the lease contract can be modified with mutual consent either before or after the delivery of the usufruct.
The provider of the usufruct under a lease contract is called the landlord or lessor and its receiver is termed as the lessee. It is not necessary that the provider of the usufruct is always the owner of the property too.
It is possible that the provider of the usufruct is actually not the owner of the asset but a lessee in another lease agreement whereby he or she had obtained the usufruct from the owner of the property, and is now acting as the sublessor in terms of the second lease agreement. Nevertheless, this can only be possible if the owner under the first lease agreement has permitted for subleasing of the asset.
Islamic banks make the best use of the Ijarah or leasing structure by developing several products around it for their retail, corporate and capital market customers. Ijarah is different from Murabahah in that the subject matter of Ijarah such as the leased asset is returned to the lessor upon the culmination of the lease contract whereas the subject matter under a Murabahah contract becomes the property of the buyer.
An Islamic bank may directly enter into an Ijarah contract with the customer if the leasing asset is readily available in its ownership and possession. However, it will not be possible for an Islamic bank to enter into an Ijarah contract in the case of absence of the asset purported to be leased. In such a situation, the Islamic bank may request the customer to provide a ‘promise to lease’ before it starts the acquisition of the asset required to be leased or enter into a forward lease contract with the customer.
Readers will remember the document ‘promise to purchase’ we discussed in the Murabahah topic which provides mitigation of a bank’s risk should the customer fail to turn up to buy the asset from the bank after the bank has acquired the same.
In a similar manner, under an Ijarah structure, the scholars have agreed by consensus to allow Islamic banks to seek from customers the ‘promise to lease’ before embarking on purchasing the asset requested to be taken on lease by the customer.
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 projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: Discussion on the Ijarah contract to continue for a number of weeks before we commence our discussion on Mudarabah.