I provide below the final paragraph of my last article 169 to refresh the situation for readers.

I recall a Sukuk Ijarah transaction I was advising on where an interesting situation was deliberated on how to cover the period from the date of serving the exercise notice to the obligor by the delegate until the receipt of the redemption amount, which may usually take a few days. The question was based on the interpretation that the lease term is deemed to be terminated upon serving the exercise notice to the obligor and hence the Sukuk investors may be deprived of the lease rent earnings for such a period.

In simple words, the issue is why should the Sukuk investors remain dry from the date of serving the exercise notice by the delegate (on behalf of the trustee shell company which in turn is representing the Sukuk investors as the lessor) to the obligor (lessee) until such time that either the obligor purchases the Sukuk asset or it is sold to a third party and the funds are made available to redeem the Sukuk?

While deliberating on this issue, it is to be kept in mind that such a period may extend to weeks if the sale proceeds are to come from the obligor, and even to months if the Sukuk asset is to be sold to a third party.

This point was submitted to the Shariah scholars by me who gave the verdict that for so long as the registered or Shariah ownership of the Sukuk asset is with the trustee shell company and the possession of the asset is with the obligor who continues to enjoy the usufruct, the lease rent shall continue to accrue for the benefit of the Sukuk investors and the obligor shall be liable to pay it to the Sukuk investors in addition to the exercise price amount claimed in the put option exercise notice. The amount stated in the notice includes the variable element ascertained until the date of the notice plus the fixed element.

As for the rate at which the lease rent shall accrue, the guidance provided by the scholars was that it shall be based on the rate applied for the last period of the lease term (ie the period just before the default and serving of the exercise notice) plus the additional margin should that be desired by the Sukuk investors, provided the extent of it is pre-agreed by the obligor.

The difference between registered and Shariah ownership was explained earlier in this space a few times but for immediate clarity please note that the Shariah ownership is where the registered title continues to remain with the obligor but the ownership to the Sukuk asset is transferred to the trustee shell company through the sale and purchase agreement.

The concept is based on the Shariah principle of concluding a sale and purchase transaction based on a simple handwritten paper signed by both parties and the witnesses (if any), or even verbally since Islam emphasizes great importance on respecting the word and fulfilling the oath, promise or pledge, even if it results in financial loss.

Therefore, a mere purchase agreement signed by the trustee shell company (or its delegate) with the obligor without getting the asset title officially registered effectively works in Shariah to transfer the pro-rata undivided ownership of the asset to the Sukuk investors, hence enabling them to lease the asset to the obligor through the trustee shell company.
Moreover, it is to be noted that the practice of a land and property sale and purchase did not need any registration with the government before the emergence of the formal land registry mechanism in 1925 in the UK. It is said that the mechanism to officially register the property was primarily introduced to generate revenue for the government coffers but it also proved highly effective to combat the ownership disputes wherever it was emulated.

Coming back to the question of compensating the Sukuk investors for the period from serving the exercise notice to the obligor until the funds are made available to redeem for the Sukuk investors, the Shariah scholars’ position was documented by inserting a clause in the lease agreement that despite serving the exercise notice to the obligor, the lease rent shall be deemed to continue to accrue on a daily basis from the date of serving the notice until such time that the obligor purchases the Sukuk asset owing to the continuance of the enjoyment of the usufruct related to the Sukuk asset by the obligor.

Critics may say that this is akin to a conventional bond transaction where the interest continues to be levied from the default date until full payment by the borrower. However, this may not be a true comparison since in Sukuk Ijarah, there is an underlying asset which has been leased and the obligor continues to benefit from the asset beyond the default date but not in the capacity as the owner.

Also, in a bond transaction, the borrower pays a penalty interest from the date it commits a default but in Sukuk Ijarah, the obligor simply pays the rent for using the asset without being forced to pay any kind of penalty.

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 Sukuk transactions shall continue.