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Head-Lease

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.

6. Penalty for Late Payment of Rent

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.

4. Liability of the Parties in Case of Loss to the Asset

As mentioned in the basic principles of leasing, the lessee is responsible for any loss caused to the asset by his misuse or negligence. He can also be made liable to the wear and tear which normally occurs during its use. But he cannot be made liable to a loss caused by the factors beyond his control. The agreements of the traditional ‘financial lease’ generally do not differentiate between the two situations. In a lease based on the Islamic principles, both the situations should be dealt with separately.

3. Expenses Consequent to Ownership

As the lessor is the owner of the asset, and he has purchased it from the supplier through his agent, he is liable to pay all the expenses incurred in the process of its purchase and its import to the country of the lessor. Consequently, he is liable to pay the freight and the customs duty etc. He can, of course, include all these expenses in his cost and can take them into consideration while fixing the rentals, but as a matter of principle, he is liable to bear all these expenses as the owner of the asset. Any agreement to the contrary, as is found in the traditional financial leases, is not in conformity with Shari‘ah.

2. Different Relations of the Parties

It should be clearly understood that when the lessee himself has been entrusted with the purchase of the asset intended to be leased, there are two separate relations between the institution and the client which come into operation one after the other. In the first instance, the client is an agent of the institution to purchase the asset on latter’s behalf. At this stage, the relation between the parties is nothing more than the relation of a principal and his agent. The relation of lessor and lessee has not yet come into operation.

The second stage begins from the date when the client takes delivery from the supplier. At this stage, the relation of lessor and lessee comes to play its role. These two capacities of the parties should not be mixed up or confused with each other. During the first stage, the client cannot be held liable for the obligations of a lessee. In this period, he is responsible to carry out the functions of an agent only. But when the asset is delivered to him, he is liable to discharge his obligations as a lessee.

However, there is a point of difference between murabahah and leasing. In murabahah, as mentioned earlier, actual sale should take place after the client takes delivery from the supplier, and the previous agreement of murabahah is not enough for effecting the actual sale. Therefore, after taking possession of the asset as an agent, he is bound to give intimation to the institution, and make an offer for the purchase from him. The sale takes place after the institution accepts the offer.

The procedure in leasing is different, and a little shorter. Here the parties need not effect the lease contract after taking delivery. If the institution, while  appointing the client its agent, has agreed to lease the asset with effect from the date of delivery, the lease will automatically start on that date without any additional procedure.

There are two reasons for this difference between murabahah and leasing:

Firstly, it is a necessary condition for a valid sale that it should be effected instantly. Thus, a sale attributed to a future date is invalid in Shari‘ah. But leasing can be attributed to a future date. Therefore, the previous agreement is not sufficient in the case of murabahah, while it is quite enough in the case of leasing. 

Secondly, the basic principle of Shari‘ah is that one cannot claim a profit or a fee for a property the risk of which was never borne by him. Applying this principle to murabahah, the seller cannot claim a profit over a property which never remained under his risk for a moment. Therefore, if the previous agreement is held to be sufficient for effecting a sale between the client and the institution, the asset shall be transferred to the client simultaneously when he takes its possession, and the asset shall not come into the risk of the seller even for a moment. That is why the simultaneous transfer is not possible in murabahah, and there should be a fresh offer and acceptance after the delivery.

In leasing, however, the asset remains under the risk and ownership of the lessor throughout the leasing period, because the ownership has not been transferred. Therefore, if the lease period begins right from the time when the client has taken delivery, it does not violate the principle mentioned above.

1. The Commencement of Lease

Unlike the contract of sale, the agreement of ijarah can be effected for a future date.[2]

Thus, while a forward sale is not allowed in Shari‘ah, an ‘ijarah’ for a future date is allowed, on the condition that the rent will be payable only after the leased asset is delivered to the lessee.

In most cases of the ‘financial lease’ the lessor i.e. the financial institution purchases the asset through the lessee himself. The lessee purchases the asset on behalf of the lessor who pays its price to the supplier, either directly or through the lessee. In some lease agreements, the lease commences on the very day on which the price is paid by the lessor, irrespective of whether the lessee has effected payment to the supplier and taken delivery of the asset or not. It may mean that lessee’s liability for the rent starts before the lessee takes delivery of the asset. This is not allowed in Shari‘ah, because it amounts to charging rent on the money given to the customer which is nothing but interest, pure and simple.

The correct way, according to Shari‘ah, is that the rent be charged after the lessee has taken delivery of the asset, and not from the day the price has been paid. If the supplier has delayed the delivery after receiving the full price, the lessee should not be liable for the rent of the period of delay.

[2] See Ibn ‘Abidin, Radd al-Muhtar, 4:64.

Lease as a Mode of Financing

Like murabahah, lease is not originally a mode of financing. It is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed period against an agreed consideration. However, certain financial institutions have adopted leasing as a mode of financing instead of long term lending on the basis of interest. This kind of lease is generally known as the ‘financial lease’ as distinguished from the ‘operating lease’ and many basic features of actual leasing transaction have been dispensed with therein.

When interest-free financial institutions were established in the near past, they found that leasing is a recognized mode of finance throughout the world. On the other hand, they realized that leasing is a lawful transaction according to Shari‘ah and it can be used as an interest-free mode of financing. Therefore, leasing has been adopted by the Islamic financial institutions, but very few of them paid attention to the fact that the ‘financial lease’ has a number of characteristics more similar to interest than to the actual lease transaction. That is why they started using the same model agreements of leasing as were in vogue among the conventional financial institutions without any modification, while a number of their provisions were not in conformity with Shari‘ah.

As mentioned earlier, leasing is not a mode of financing in its origin. However, the transaction may be used for financing, subject to certain conditions. It is not sufficient for this purpose to substitute the name of ‘interest’ by the name of ‘rent’ and replace the name of ‘mortgage’ by the name of ‘leased asset’. There must be a substantial difference between leasing and an interest-bearing loan. That will be possible only by following all the Islamic rules of leasing, some of which have been mentioned in the first part of this chapter.

To be more specific, some basic differences between the contemporary financial leasing and the actual leasing allowed by the Shari‘ah are indicated in the next posts. 

Basic Rules of Leasing

1. Leasing is a contract whereby the owner of something transfers its usufruct to another person for an agreed period, at an agreed consideration.

2. The subject of lease must have a valuable use. Therefore, things having no usufruct at all cannot be leased.

3. It is necessary for a valid contract of lease that the corpus of the leased property remains in the ownership of the seller, and only its usufruct is transferred to the lessee. Thus, anything which cannot be used without consuming cannot be leased out. Therefore, the lease cannot be effected in respect of money, eatables, fuel and ammunition etc. because their use is not possible unless they are consumed. If anything of this nature is leased out, it will be deemed to be a loan and all the rules concerning the transaction of loan shall accordingly apply. Any rent charged on this invalid lease shall be an interest charged on a loan.

4. As the corpus of the leased property remains in the ownership of the lessor, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property shall be borne by the lessee.

Example: A has leased his house to B. The taxes referable to the property shall be borne by A, while the water tax, electricity bills and all expenses referable to the use of the house shall be borne by B, the lessee.

5. The period of lease must be determined in clear terms.

6. The lessee cannot use the leased asset for any purpose other than the purpose specified in the lease agreement. If no such purpose is specified in the agreement, the lessee can use it for whatever purpose it is used in the normal course. However if he wishes to use it for an abnormal purpose, he cannot do so unless the lessor allows him in express terms.

7. The lessee is liable to compensate the lessor for every harm to the leased asset caused by any misuse or negligence on the part of the lessee.

8. The leased asset shall remain in the risk of the lessor throughout the lease period in the sense that any harm or loss caused by the factors beyond the control of the lessee shall be borne by the lessor.

9. A property jointly owned by two or more persons can be leased out, and the rental shall be distributed between all the joint owners according to the proportion of their respective shares in the property.

10. A joint owner of a property can lease his proportionate share to his co-sharer only, and not to any other person.[1]

11. It is necessary for a valid lease that the leased asset is fully identified by the parties.

Example: A said to B. “I lease you one of my two shops.” B agreed. The lease is void, unless the leased shop is clearly determined and identified.

12. The rental must be determined at the time of contract for the whole period of lease. It is permissible that different amounts of rent are fixed for different phases during the lease period, provided that the amount of rent for each phase is specifically agreed upon at the time of effecting a lease. If the rent for a subsequent phase of the lease period has not been determined or has been left at the option of the lessor, the lease is not valid.

Example (1): A leases his house to B for a total period of 5 years. The rent for the first year is fixed as Rs. 2000/- per month and it is agreed that the rent of every subsequent year shall be 10% more than the previous one. The lease is valid.

Example (2): In the above example, A puts a condition in the agreement that the rent of Rs. 2000/- per month is fixed for the first year only. The rent for the subsequent years shall be fixed each year at the option of the lessor. The lease is void, because the rent is uncertain.

The determination of rental on the basis of the aggregate cost incurred in the purchase of the asset by the lessor, as normally done in financial leases, is not against the rules of Shari‘ah, if both parties agree to it, provided that all other conditions of a valid lease prescribed by the Shari‘ah are fully adhered to.

14. The lessor cannot increase the rent unilaterally, and any agreement to to this effect is void.

15. The rent or any part thereof may be payable in advance before the delivery of the asset to the lessee, but the amount so collected by the lessor shall remain with him as ‘on account’ payment and shall be adjusted towards the rent after its being due.

16. The lease period shall commence from the date on which the leased asset has been delivered to the lessee, no matter whether the lessee has started using it or not.

17. If the leased asset has totally lost the function for which it was leased, and no repair is possible, the lease shall terminate on the day on which such loss has been caused. However, if the loss is caused by the misuse or by the negligence of the lessee, he will be liable to compensate the lessor for the depreciated value of the asset as, it was immediately before the loss.

[1] See Ibn ‘Abidin, Radd al-Muhtar, 6:47–48.

6  -  Ijarah

“Ijarah” is a term of Islamic fiqh. Lexically, it means ‘to give something on rent’. In the Islamic jurisprudence, the term ‘ijarah’ is used for two different situations. In the first place, it means ‘to employ the services of a person on wages given to him as a consideration for his hired services.’ The employer is called musta’jir while the employee is called ajir.

Therefore, if A has employed B in his office as a manager or as a clerk on a monthly salary, A is musta’jir, and B is an ajir. Similarly, if A has hired the services of a porter to carry his baggage to the airport, A is a musta’jir while the porter is an ajir, and in both cases the transaction between the parties is termed as ijarah. This type of ijarah includes every transaction where the services of a person are hired by someone else. He may be a doctor, a lawyer, a teacher, a laborer or any other person who can render some valuable services. Each one of them may be called an ‘ajir’ according to the terminology of Islamic law, and the person who hires their services is called a ‘musta’jir’, while the wages paid to the ajir are called their ‘ujrah’.

The second type of ijarah relates to the usufructs of assets and properties, and not to the services of human beings. ‘Ijarah’ in this sense means ‘to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him.’ In this case, the term ‘ijarah’ is analogous to the English term ‘leasing’. Here the lessor is called ‘mu’jir’, the lessee is called ‘musta’jir’ and the rent payable to the lessor is called ‘ujrah’.

Both these kinds of ‘ijarah’ are thoroughly discussed in the literature of Islamic jurisprudence and each one of them has its own set of rules. But for the purpose of the present book, the second type of ijarah is more relevant, because it is generally used as a form of investment, and as a mode of financing also.

The rules of ijarah, in the sense of leasing, is very much analogous to the rules of sale, because in both cases something is transferred to another person for a valuable consideration. The only difference between ijarah and sale is that in the latter case the corpus of the property is transferred to the purchaser, while in the case of ijarah, the corpus of the property remains in the ownership of the transferor, but only its usufruct i.e. the right to use it, is transferred to the lessee.

Therefore, it can easily be seen that ‘ijarah’ is not a mode of financing in its origin. It is a normal business activity like sale.

However, due to certain reasons, and in particular, due to some tax concessions it may carry, this transaction is being used in the Western countries for the purpose of financing also. Instead of giving a simple interest - bearing loan, some financial institutions started leasing some equipment’s to their customers. While fixing the rent of these equipment, they calculate the total cost they have incurred in the purchase of these assets and add the stipulated interest they could have claimed on such an amount during the lease period. The aggregate amount so calculated is divided on the total months of the lease period, and the monthly rent is fixed on that basis.

The question whether or not the transaction of leasing can be used as a mode of financing in Shari‘ah depends on the terms and conditions of the contract. As mentioned earlier, leasing is a normal business transaction and not a mode of financing. Therefore, the lease transaction is always governed by the rules of Shari‘ah prescribed for ijarah. Let us, therefore, discuss the basic rules governing the lease transactions, as enumerated in the Islamic Fiqh. After the study of these rules, we will be able to understand under what conditions the ijarah may be used for the purpose of financing.

Although the principles of ijarah are so numerous that a separate volume is required for their full discussion, we will attempt in this chapter to summarize those basic principles only which are necessary for the proper understanding of the nature of the transaction and are generally needed in the context of modern economic practice. These principles are recorded here in the form of brief notes, so that the readers may use them for quick reference.

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