Unfortunately, I did not receive any correct response to my question of if the lessor was asked to bear the cost of all major maintenance to the Sukuk asset, how shall the risk of diminution or decrease in the return or profit to the Sukukholders be addressed?
Let me first explain the question which may not have been correctly posed by me. If the lessor is required, as per Shariah principles, to bear the cost of keeping the leased asset in good working condition, it will need to spend the money to do so. This is irrespective of the nature of the asset being simple such as real estate, or technical such as aircraft.
The question is, if the lessor entity (the trustee shell company) representing the Sukukholders uses the amount of periodic rent it receives from the lessee toward maintaining the leased asset, certainly the Sukukholders shall be deprived of getting the full amount of rent which shall in turn impact their expected return which, in the first place, influenced them to make the decision to purchase the Sukuk Ijarah.
For example, if the Sukuk offered an expected return on investment at 6% per annum emanating from the lease rent paid by the lessee, and the lessor (trustee shell company representing the Sukukholders) apportioned a considerable rent amount on the upkeep of the leased asset to meet the Shariah condition for leasing, and as a result it considerably reduced the return to Sukukholders to less than 4% per annum, what is the Shariah solution to restore the Sukukholders’ dividend to their expectation based on the Sukuk prospectus?
Before I discuss the Shariah compliant solution, I would like to ask you, the readers, a question. Assuming one of you have a property which you have been renting for a considerable period of time. When it was vacated by the last tenant, you decided to renovate it and spent a large amount of money for the purpose. The refurbishment included change of tiles, upgrading the gadgets, replacing the air-conditioning or heating system and repainting the interior and exterior, and the property has been brought back to its original shape, or even better.
Would you still rent the property at the old rate to a new tenant? Of course not. You will hike up the rent to match the quality of the upgraded property and also to be able to get back the amount of money you have just spent on it. So, what you will do is to distribute the total amount spent on revamping the property over a period of time to ensure that you retrieve the invested amount within a reasonable period of time together with the profit. And this is perfectly alright from a Shariah standpoint.
Borrow this concept to apply on Sukuk Ijarah. The agreement to appoint the lessee as the service agent contains a provision to the effect that the principal (lessor) shall either make the advance payment to the agent to be able to carry out the major maintenance to the leased asset as and when it falls due, or shall immediately reimburse the agent upon receipt of the proof that the agent has spent the money for carrying out the needed maintenance.
In the latter scenario, the position is that the agent has granted an interest-free loan (Qard Hasan) to the principal, equivalent to the amount spent by the agent on carrying out the major maintenance, and that it is the responsibility of the principal not to let the agent wait for the amount since this situation is not desirable from a Shariah perspective.
On the other hand, and in order to balance the equation and safeguard the Sukukholders’ interest so that they receive the anticipated return on investment, another provision is added in the lease agreement stating that if the lessee, acting as the servicing agent, has claimed reimbursement in terms of the servicing agency agreement, the lessor is eligible to increase the rent for the next rental period by the same amount under the supplementary rent.
As such, the rent for the next rental period pursuant to the lessor (acting as the principal under the servicing agency agreement) having reimbursed the major maintenance cost to the lessee (acting as the servicing agent) shall be comprised of two elements viz. the variable element and the supplementary element. This Shariah compliant mechanism will ensure that the overall return to the investment made by the Sukukholders shall be maintained at the desired level, one which was indicated in the Sukuk prospectus.
Some of you may argue that if the return on the Sukuk Ijarah investment is predefined in such a manner, how different is it from conventional bonds? Now, my apology for the inconvenience but you will have to refer to the very early articles in this series wherein I had demarcated the differences between sale and investment contracts. One of the differences was that in a sale contract, the seller gets to know the amount of profit (or loss) it will incur at the outset, ie at the time of entering into the contract.
Since the Ijarah contract deals with the sale of usufruct of the leased asset for a defined period, it falls in the same genre as the Murabahah contract where the profit is known at the time of signing the contract. Hence, it is very much in line with the Shariah principles for a Sukuk Ijarah prospectus to let the investors know beforehand as to what shall be the rate of return on their investment.
What if the servicing agent does carry out the major maintenance of the leased asset but does not claim the reimbursement from the principal (lessor) under the servicing agency agreement? A penny for your thoughts?
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: Discussion on the Sukuk procedures shall continue.