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Variable Rentals in Long Term
Leases ( Top
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In the long term lease agreements it is mostly not in the benefit
of the lessor to fix one amount of rent for the whole period of lease,
because the market conditions change from time to time.
In this case
the lessor has two options:
(a) He can contract lease with
a condition that the rent shall be increased according to a specified
proportion (e.g. 5%) after a specified period (like one year).
(b) He can contract lease for a shorter period after which
the parties can renew the lease at new terms and by mutual consent, with
full liberty to each one of them to refuse the renewal, in which case the
lessee is bound to vacate the leased property and return it back to the
lessor.
These two options are available to the lessor according to
the classical rules of Islamic Fiqh. However, some contemporary scholars
have allowed, in long-term leases, to tie up the rental amount with a
variable benchmark which is so well-known and well-defined that it does
not leave room for any dispute. For example, it is permissible according
to them to provide in the lease contract that in case of any increase in
the taxes imposed by the government on the lessor, the rent will be
increased to the extent of same amount. Similarly it is allowed by them
that the annual increase in the rent is tied up with the rate of
inflation. Therefore if there is an increase of 5% in the rate of
inflation, it will result in an increase of 5% in the rent as well. Based
on the same principle, some Islamic banks use the rate of interest as a
benchmark to determine the rental amounts. They want to earn the same
profit through leasing as is earned by the conventional banks through
advancing loans on the basis of interest. Therefore, they want to tie up
the rentals with the rate of interest and instead of fixing a definite
amount of rental, they calculate the cost of purchasing the lease assets
and want to earn through rentals an amount equal to the rate of interest.
Therefore, the agreement provides that the rental will be equal to the
rate of interest or to the rate of interest plus something. Since the rate
of interest is variable, it cannot be determined for the whole lease
period. Therefore, these contracts use the interest rate of a particular
country (like LIBOR) as a benchmark for determining the periodical
increase in the rent.
This arrangement has been criticized on two
grounds:
The first objection raised against it is that, by subjecting
the rental payments to the rate of interest, the transaction is rendered
akin to an interest based financing. This objection can be overcome by
saying that, as fully discussed in the case of murabahah, the rate of
interest is used as a benchmark only. So far as other requirements of
Shari‘ah for a valid lease are properly fulfilled, the contract may use
any benchmark for determining the amount of rental. The basic difference
between an interest - based financing and a valid lease does not lie in
the amount to be paid to the financier or the lessor. The basic difference
is that in the case of lease, the lessor assumes the full risk of the
corpus of the leased asset. If the asset is destroyed during the lease
period, the lessor will suffer the loss. Similarly, if the leased asset
looses its usufruct without any misuse or negligence on the part of the
lessee, the lessor cannot claim the rent, while in the case of an
interest-based financing, the financier is entitled to receive interest,
even if the debtor did not at all benefit from the money borrowed. So far
as this basic difference is maintained, (i.e. the lessor assumes the risk
of the leased asset) the transaction cannot be categorised as an
interest-bearing transaction, even though the amount of rent claimed from
the lessee is equal to the rate of interest.
It is thus clear that the
use of the rate of interest merely as a benchmark does not render the
contract invalid as an interest - based transaction. It is, however,
advisable at all times to avoid using interest even as a benchmark, so
that an Islamic transaction is totally distinguished from an un-Islamic
one, having no resemblance of interest whatsoever.
The second
objection to this arrangement is that the variations of the rate of
interest being unknown, the rental tied up with the rate of interest will
imply Jahalah and Gharar which is not permissible in Shari‘ah. It is one
of the basic requirements of Shari‘ah that the consideration in every
contract must be known to the parties when they enter into it. The
consideration in a transaction of lease is the rent charged from the
lessee, and therefore it must be known to each party right at the
beginning of the contract of lease. If we tie up the rental with the
future rate of interest, which is unknown, the amount of rent will remain
unknown as well. This is the Jahalah or Gharar which renders the
transaction invalid.
Responding to this objection, one may say that
the Jahalah has been prohibited for two reasons: One reason is that it may
lead to dispute between the parties. This reason is not applicable here,
because both parties have agreed with mutual consent upon a well defined
benchmark that will serve as a criterion for determining the rent, and
whatever amount is determined, based on this benchmark, will be acceptable
to both parties. Therefore, there is no question of any dispute between
them.
The Second reason for the prohibition of Jahalah is that it
renders the parties susceptible to an unforeseen loss. It is possible that
the rate of interest, in a particular period, zooms up to an unexpected
level in which case the lessee will suffer. It is equally possible that
the rate of interest zooms down to an unexpected level, in which case the
lessor may suffer. In order to meet the risks involved in such
possibilities, it is suggested by some contemporary scholars that the
relation between rent and the rate of interest is subjected to a limit or
ceiling. For example, it may be provided in the base contract that the
rental amount after a given period, will be changed according to the
change in the rate of interest, but it will in no case be higher than 15%
or lower than 5% of the previous monthly rent. It will mean that if the
increase in the rate of interest is more than 15% the rent will be
increased only up to 15%. Conversely, if the decrease in the rate of
interest is more than 5% the rent will not be decreased to more than 5%.
In our opinion, this is the moderate view which takes care of all the
aspects involved in the issue.
Penalty for
Late Payment of Rent ( Top
)
In some agreements of financial leases, a penalty is imposed on the
lessee in case he delays the payment of rent after the due date. This
penalty, if meant to add to the income of the lessor, is not warranted by
the Shari‘ah. The reason is that the rent after it becomes due, is a debt
payable by the lessee, and is subject to all the rules prescribed for a
debt. A monetary charge from a debtor for his late payment is exactly the
riba prohibited by the Holy Qur’an. Therefore, the lessor cannot charge an
additional amount in case the lessee delays payment of the rent.
However, in order to avoid the adverse consequences resulting from
the misuse of this prohibition, another alternative may be resorted to.
The lessee may be asked to undertake that, if he fails to pay rent on its
due date, he will pay certain amount to a charity. For this purpose the
financier / lessor may maintain a charity fund where such amounts may be
credited and disbursed for charitable purposes, including advancing
interest-free loans to the needy persons. The amount payable for
charitable purposes by the lessee may vary according to the period of
default and may be calculated at per cent, per annum basis . The agreement
of the lease may contain the following clause for this purpose:
"The Lessee hereby undertakes that, if he fails to pay rent at its
due date, he shall pay an amount calculated at ....% p.a. to the charity
Fund maintained by the Lessor which will be used by the Lessor exclusively
for charitable purposes approved by the Shari‘ah and shall in no case form
part of the income of the Lessor."
This arrangement, though does not
compensate the lessor for his opportunity cost of the period of default,
yet it may serve as a strong deterrent for the lessee to pay the rent
promptly.
The justification for such undertaking of the lessee,
and inability of any penalty or compensation claimed by the lessor for his
own benefit is discussed in full in the chapter of 'Murabahah' in the
present book which may be consulted for details.
Termination of lease ( Top
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If the lessee contravenes any term of the agreement, the lessor
has a right to terminate the lease contract unilaterally. However, if
there is no contravention on the part of the lessee, the lease cannot be
terminated without mutual consent. In some agreements of the 'financial
lease' it has been noticed that the lessor has been given an unrestricted
power to terminate the lease unilaterally whenever he wishes, according to
his sole judgment. This is again contrary to the principles of Shari‘ah.
In some agreements of the 'financial lease' a condition has been
found to the effect that in case of the termination of lease, even at the
option of the lessor, the rent of the remaining lease period shall be paid
by the lessee. This condition is obviously against Shari‘ah and the
principles of equity and justice. The basic reason for inserting such
conditions in the agreement of lease is that the main concept behind the
agreement is to give an interest-bearing loan under the ostensible cover
of lease. That is why every effort is made to avoid the logical
consequences of the lease contract.
Naturally, such a condition
cannot be acceptable to Shari‘ah. The logical consequence of the
termination of lease is that the asset should be taken back by the lessor.
The lessee should be asked to pay the rent as due up to the date of
termination. If the termination has been effected due to the misuse or
negligence on the part of the lessee, he can also be asked to compensate
the lessor for the loss caused by such misuse or negligence. But he cannot
be compelled to pay the rent of the remaining period.
Insurance of the assets ( Top
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If the leased property is insured under the Islamic mode of takaful,
it should be at the expense of the lessor and not at the expense of the
lessee, as is generally provided in the agreements of the current
'financial leases'.
The residual value of the leased asset
Another important feature of the modern 'financial leases' is that
after the expiry of the lease period, the corpus of the leased asset is
normally transferred to the lessee. As the lessor already recovers his
cost along with an additional profit thereon, which is normally equal to
the amount of interest which could have been earned on a loan of that
amount advanced for that period, the lessor has no further interest in the
leased asset. On the other hand, the lessee wants to retain the asset
after the expiry of the leased period.
For these reasons, the
leased asset is generally transferred to the lessee at the end of the
lease, either free of any charge or at a nominal token price. In order to
ensure that the asset will be transferred to the lessee, sometimes the
lease contract has an express clause to this effect. Sometimes this
condition is not mentioned in the contract expressly; however, it is
understood between the parties that the title of the asset will be passed
on to the lessee at the end of the lease term.
This condition,
whether it is express or implied, is not in accordance with the principles
of Shari‘ah. It is a well settled rule of Islamic jurisprudence that one
transaction cannot be tied up with another transaction so as to make the
former a pre-condition for the other. Here the transfer of the asset at
the end has been made a necessary condition for the transaction of lease
which is not allowed in Shari‘ah.
The original position in
Shari‘ah is that the asset shall be the sole property of the lessor, and
after the expiry of the lease period, the lessor shall be at liberty to
take the asset back, or to renew the lease or to lease it out to another
party, or sell it to the lessee or to any other person. The lessee cannot
force him to sell it to him at a nominal price, nor can such a condition
be imposed on the lessor in the lease agreement.
But after the
lease period expires, and the lessor wants to give the asset to the lessee
as a gift or to sell it to him, he can do so by his free will. However,
some contemporary scholars, keeping in view the needs of the Islamic
financial institutions have come up with an alternative. They say that the
agreement of Ijarah itself should not contain a condition of gift or sale
at the end of the lease period. However, the lessor may enter into a
unilateral promise to sell the leased asset to the lessee at the end of
the lease period. This promise will be binding on the lessor only. The
principle, according to them, is that a unilateral promise to enter into a
contract at a future date is allowed whereby the promisor is bound to
fulfil the promise, but the promisee is not bound to enter into that
contract . It means that he has an option to purchase which he may or may
not exercise. However, if he wants to exercise his option to purchase, the
promisor cannot refuse it because he is bound by his promise. Therefore,
these scholars suggest that the lessor, after entering into the lease
agreement, can sign a separate unilateral promise whereby he undertakes
that if the lessee has paid all the amounts of rentals and wants to
purchase the asset at a specified mutually acceptable price, he will sell
the leased asset to him for that price.
Once this promise is
signed by the lessor, he is bound to fulfil it and the lessee may exercise
his option to purchase at the end of the period, if he has fully paid the
amounts of rent according to the agreement of lease. Similarly, it is also
allowed by these scholars that, instead of sale, the lessor signs a
separate promise to gift the leased asset to the lessee at the end of the
lease period, subject to his payment of all amounts of rent. This
arrangement is called 'Ijarah wa iqtina’. It has been allowed by a large
number of contemporary scholars and is widely acted upon by the Islamic
banks and financial institutions. The validity of this arrangement is
subject to two basic conditions:
Firstly, the agreement of Ijarah
itself should not be subjected to signing this promise of sale or gift but
the promise should he recorded in a separate document.
Secondly, the
promise should be unilateral and binding on the promisor only. It should
not be a bilateral promise binding on both parties because in this case it
will be a full contract effected to a future date which is not allowed in
the case of sale or gift.
Sub-Lease (
Top
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If the leased asset is used differently by different users, the
lessee cannot sub-lease the leased asset except with the express
permission of the lessor. If the lessor permits the lessee for subleasing,
he may sub-lease it. If the rent claimed from the sub-lessee is equal to
or less than the rent payable to the owner / original lessor, all the
recognized schools of Islamic jurisprudence are unanimous on the
permissibility of the sub lease. However, the opinions are different in
case the rent charged from the sub-lessee is higher than the rent payable
to the owner. Imam al-Shafi‘i and some other scholars allow it and hold
that the sub lessor may enjoy the surplus received from the sub-lessee.
This is the preferred view in the Hanbali school as well. On the other
hand. Imam Abu Hanifah is of the view that the surplus received from the
sub-lessee in this case is not permissible for the sub-lessor to keep and
he will have to give that surplus in charity. However, if the sub-lessor
has developed the leased property by adding something to it or has rented
it in a currency different from the currency in which he himself pays rent
to the owner/the original lessor, he can claim a higher rent from his
sub-lessee and can enjoy the surplus.
Although the view of Imam
Abu Hanifah is more precautions which should be acted upon to the best
possible extent, in cases of need the view of Shafi‘i and Hanbali schools
may be followed because there is no express prohibition in the Holy Qur’an
or in the Sunnah against the surplus claimed from the lessee. Ibn Qudamah
has argued for the permissibility of surplus on forceful grounds.
Assigning of the Lease ( Top
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The lessor can sell the leased property to a third party whereby the
relation of lessor and lessee shall be established between the new owner
and the lessee. However, the assigning of the lease itself (without
assigning the ownership in the leased asset) for a monetary consideration
is not permissible.
The difference between the two situations is
that in the latter case the ownership of the asset is not transferred to
the assignee, but he becomes entitled to receive the rent of the asset
only. This kind of assignment is allowed in Shari‘ah only where no
monetary consideration is charged from the assignee for this assignment.
for example, a lessor can assign his right to claim rent from the lessee
to his son, or to his friend in the form of a gift. Similarly, he can
assign this right to any one of his creditors to set off his debt out of
the rentals received by him. But if the lessor wants to sell this right
for a fixed price, it is not permissible, because in this case the money
(the amount of rentals) is sold for money which is a transaction subject
to the principle of equality. Otherwise it will be tantamount to a riba
transaction, hence prohibited.
Securitization of Ijarah ( Top
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The arrangement of Ijarah has a good potential of securitization
which may help create a secondary market for the financiers on the basis
of Ijarah. Since the lessor in Ijarah owns the leased assets, he can sell
the asset, in whole or in part, to a third party who may purchase it and
may replace the seller in the rights and obligations of the lessor with
regard to the purchased part of the asset.
Therefore, if the
lessor, after entering into Ijarah, wishes to recover his cost of purchase
of the asset with a profit thereon, he can sell the leased asset wholly or
partly either to one party or to a number of individuals. In the latter
case, the purchase of a proportion of the asset by each individual may be
evidenced by a certificate which may be called 'Ijarah certificate'. This
certificate will represent the holder's proportionate ownership in the
leased asset and he will assume the rights and obligations of the
owner/lessor to that extent. Since the asset is already leased to the
lessee, lease will continue with the new owners, each one of the holders
of this certificate will have the right to enjoy a part of the rent
according to his proportion of ownership in the asset. Similarly he will
also assume the obligations of the lessor to the extent of his ownership.
Therefore, in the case of total destruction of the asset, he will suffer
the loss to the extent of his ownership. These certificates, being an
evidence of proportionate ownership in a tangible asset, can be negotiated
and traded in freely in the market and can serve as an instrument easily
convertible into cash. Thus they may help in solving the problems of
liquidity management faced by the Islamic banks and financial
institutions.
It should be remembered, however, that the
certificate must represent ownership of an undivided part of the asset
with all its rights and obligations. Misunderstanding this basic concept,
some quarters tried to issue Ijarah certificates representing the holder's
right to claim certain amount of the rental only without assigning to him
any kind of ownership in the asset. It means that the holder of such a
certificate has no relation with the leased asset at all. His only right
is to share the rentals received from the lessee. This type of
securitization is not allowed in Shari‘ah. As explained earlier in this
chapter, the rent after being due is a debt payable by the lessee. The
debt or any security representing debt only is not a negotiable instrument
in Shari‘ah, because trading in such an instrument amounts to trade in
money or in monetary obligation which is not allowed, except on the basis
of equality, and if the equality of value is observed while trading in
such instruments, the very purpose of securitization is defeated.
Therefore, this type of Ijarah certificates cannot serve the purpose of
creating a secondary market. It is, therefore, necessary that the Ijarah
certificates are designed to represent real ownership of the leased
assets, and not only a right to receive rent.
Head-Lease ( Top
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Another concept developed in the modern leasing business is that of
'head-leasing.' In this arrangement a lessee sub-leases the property to a
number of sub-lessees. Then, he invites others to participate in his
business by making them share the rentals received by his sub-lessees. For
making them participate in receiving rentals, he charges a specified
amount from them. This arrangement is not in accordance with the
principles of Shari‘ah. The reason is obvious. The lessee does not own the
property. He is entitled to benefit from its usufruct only. That usufruct
he has passed on to his sub-lessees by contracting a sub-lease with them.
Now he does not own anything, neither the corpus of the property, nor its
usufruct. What he has is the right to receive rent only. Therefore, he
assigns a part of this right to other persons. It is already explained in
detail that this right cannot be traded in, because it amounts to selling
a receivable debt at a discount which is one of the forms of riba
prohibited by the Holy Qur’an and Sunnah. Therefore, this concept is not
acceptable.
These are some basic features of the 'financial lease'
which are not in conformity with the dictates of Shari‘ah. While using the
lease as an Islamic mode of finance, these shortcomings must be avoided.
The list of the possible shortcomings in the lease agreement is
not restricted to what has been mentioned above, but only the basic errors
found in different agreements have been pointed out, and the basic
principles of Islamic leasing have been summarized. An Islamic lease
agreement must conform to all of
them.
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