Presentation Outline • Concept of Ijarah • Process of Ijarah • AAOIFI Shari’a Standard # 9 Promise to Lease Acquisition of the Asset Subject Matter of Ijarah Rules governing Lease Rentals Guarantees in Ijarah Contract Transfer of Ownership
Concept of Ijarah
IJARAH • Literally Ijarah means “To give something on rent” • The term “Ijarah” is used in two context: 1. ‘To employ the services of a person on wages’ e.g. “A” hires a porter at the airport to carry his luggage. 2. Another type of Ijarah relates to paying rent for use of an asset or property defined as “LAND” in Islamic Economics
IJARAH • Ijarah is an Islamic alternative of Leasing. • Leasing backed by an acceptable contract is an acceptable transaction under Shariah. • The question of whether or not the transaction of leasing is Shariah compliant depends on the terms and conditions of the contract. • Several characteristics of conventional agreements may not conform to Shariah, thus making the transaction un-Islamic and thereby invoking a prohibition.
Process of Ijarah
The customer approaches the Bank with the request for financing and enters into a promise to lease agreement. The Bank purchases the item required for leasing and receives title of ownership from the vendor The Bank makes payment to the vendor
VENDOR ISLAMIC BANK
The Bank leases the asset to the customer after execution of lease agreement. The customer makes periodic payments as per the contract. Title transfers to the customer at the end of lease term.
Rules of Ijarah
Promise to Lease Master Agreement • A master agreement may be drawn up covering a number of Ijarah transactions between the institution and the customer, setting out the general terms and conditions of agreement between the two parties. • There may either be a separate lease contract for each transaction, or alternatively the two parties may exchange notices of offer and acceptance by referring to the terms and conditions contained in the master agreement.
Promise to Lease Security Deposit • It is permissible to require the lease promisor (customer) to pay a sum of money to the institution to guarantee the customer’s commitment of accepting a lease on the asset and the subsequent obligations. • If the customer breaches his promise, the actual damage/loss may be recovered from such security deposit
Acquisition of Asset • The lease contract should be preceded by acquisition of either the asset to be leased or the usufruct of that asset. • If the asset is to be acquired from the customer, or from a third party, the Ijarah contract shall not be executed unless and until the institution has acquired that asset. • An asset may be acquired from a party and then leased to the same party (Sale & Leaseback) provided the Ijarah transaction is not stipulated as a condition of the purchase contract.
Acquisition of Asset Agency • An institution may appoint one of its customers to act as its agent in acquiring on its behalf an asset that is desired by that customer. However, It is preferred that the agent is someone other than the customer.
Acquisition of Asset Joint Ownership • A customer may jointly acquire an asset that he wishes to lease with the institution, and then lease the institution’s share of the asset from the institution (Ijarah-tul-Musha’). • The rental specified as receivable by the institution should only be in proportion to its share in the ownership of the asset.
Execution of Ijarah • The lease contract is a binding contract which neither party may terminate or alter without the consent of other party. Duration • The duration of an Ijarah contract must be specified in the contract. • The period should commence on the date of execution of the contract.
Execution of Ijarah • No rental is due for the period between the contract date and the date of actual delivery, if the lessor fails to deliver the asset on the date specified in the Ijarah contract. Subject Matter • The leased asset must be capable of being used while preserving the asset, and the benefit from an Ijarah must be lawful in Shari’a. • Subject matter may be a share in an undivided asset held in common with the lessee.
Execution of Ijarah • The lessee must use the leased asset in a suitable manner or in conformity with common practice / Sharia’a rulings. • The lessor must accept the responsibility for any defects of the leased asset which impair the intended use of the asset, either by his own doing or as a result of events outside his control. • If the benefit from the leased asset is impaired wholly or partially as a result of the lessee’s misconduct, the lessee is obliged to restore or repair the usufruct.
Execution of Ijarah Major Maintenance • The lessor is liable to undertake Major Maintenance of the asset that is required to keep the asset in the condition necessary to provide contractual benefits under the lease. • The lessor may delegate to the lessee such task at the lessor’s cost. Ordinary Maintenance • The lessee should carry out operating or periodical (ordinary) maintenance.
Execution of Ijarah Insurance of the asset • The lessor may take out permissible insurance on the leased asset whenever possible • Such insurance expenses must be borne by the lessor which may be taken into account implicitly when the lease rental is to be fixed. • The lessor may delegate to the lessee such task at the lessor’s expense.
Execution of Ijarah Lease Rentals • The rental must be specified, either as lump sump or by installments. • The lessor’s entitlement to the rental starts from the time when the lessee starts to benefit from the asset or once the lessor makes the usufruct of the asset available to the lessee.
Execution of Ijarah Variable Rentals
• In case the rental is subject to changes (floating rental), it is necessary that the amount of the rental of the first period of Ijarah contract be specified. It is then permissible that the rentals for subsequent periods be determined according to a certain benchmark. The benchmark must be based on a clear formula which is not subject to dispute and should be subject to a ceiling, on both maximum and minimum levels.
Guarantees Delay in Payment • No increase in the rental due may be stipulated by the lessor in case of delay in payment by the lessee. • It may be provided in the contract of Ijarah that a lessee who delays payment for no good reason undertakes to donate to charitable causes a certain amount or percentage of the rental due.
Selling of Leased Asset • If the lessor sells the leased asset to the lessee, the Ijarah contract is terminated due to transfer the ownership of the asset. • The lessor may sell the leased asset to a third party other than the lessee, and title to the asset together with the rights and obligations of the lessor under the Ijarah contract is thereby transferred to the new owner.
Destruction of Asset • In case of total destruction of the leased asset, the Ijarah contract is terminated if it is concluded on an identified asset. In such a case, it may not be stipulated that the rest of the installments should be paid. • The leased asset in the possession of the lessee is held by the lessee in a fiduciary capacity on behalf of the lessor. The lessee will be held liable for any damage or destruction of the leased asset due to his misconduct or negligence.
Destruction of Asset Partial Destruction • In case of the partial destruction of the leased asset in a manner that impairs the benefits expected from the asset, the lessee may terminate the Ijarah contract. • Both the lessee and the lessor may also agree to amend the rental in case of partial destruction of the leased property. • The lessor is not entitled to rent for the period during which the lessee was not able to benefit from the asset.
Destruction of Asset • If the lessee stops using the leased asset or returns it to the owner without the owner’s consent, the rental will continue to be due in respect of the remaining period of Ijarah, and the lessor may not lease the property to another lessee for this period.
Termination of Contract • The lease contract can be terminated by mutual consent but: It is not permissible for one party to terminate it except in case of force majeure or there is a defect in the leased asset that materially impairs its use. • The lessor may stipulate that the Ijarah contract be terminated if the lessee does not pay the rent or fails to pay it on time. • An Ijarah contract does not terminate with the death of either party thereto.
Renewal of the Contract • An Ijarah may be renewed for another term, and such renewal may be made: before the expiry of the original term or automatically by adding a provision in the new contract for such renewal when the new term starts.
Transfer of Ownership • In Ijarah Muntahia Bittamleek, the method of transferring the title to the lessee can be one of the following: a) A promise to sell for a token or other consideration, or by accelerating the payment of the remaining amount of rental, or by paying the market value of the leased property. b) A promise to give it as a gift (for no consideration). c) A promise to give it as a gift, contingent upon the payment of the remaining installments.
Transfer of Ownership
• The transfer of title must be evidenced in a separate document independent of the contract of Ijarah Muntahia Bittamleek and cannot be taken as an integral part of Ijarah contract. A promise to transfer the ownership is a binding promise by the lessor. Such promise is binding on the lessor only, while the lessee has the option not to proceed. In cases of transfer of ownership by way of gift or sale, it is necessary that a new contract be drawn up to affect the transfer of ownership.
Transfer of Ownership • Transfer of the ownership in the leased property cannot be made by executing, along with Ijarah, a sale contract that will become effective on a future date.
Difference b/w Conventional Lease & Ijarah
Conventional Lease Vs Ijarah Difference b/w Conventional Lease & Ijarah 1. The Lessor cannot increase the rent unilaterally 2. Expenses to be borne by the parties: • Lessor- expenses relating to the corpus of the asset i.e. insurance, accidental repairs etc. will be borne by the lessor • Lessee- actual operating/overhead expenses related to running the asset will be borne by the lessee
Conventional Lease Vs Ijarah Difference b/w Conventional Lease & Ijarah 3. Two contracts into one contract is not permissible in Shariah therefore, we cannot have the agreement of hire and purchase into one agreement, only we can undertake/promise to purchase the leased asset 4. Under conventional Lease, the Lease rental starts from the date of payment by Lessor.Under Shariah, the correct way to charge rent is after delivery of the asset to the Lessee. Because rent is charged for use of the asset
Sale & Leaseback Guidelines
Sale and Lease Back
• In Sale and Lease Back (SLB) transaction, Customer requires finance for an asset already in the ownership of the Customer. • Ideally SLB transactions should be avoided and this option should not be offered to the Customer in the initial interaction as a regular financing solution. • It should be used in exceptional cases and care should be taken to ensure that the transaction is genuine and not merely a source of liquidity /overdraft facility or a substitute of personal financing.
Sale and Lease Back
• If the leased asset was purchased from the lessee before it was leased back to the lessee on the basis of Ijarah Muntahia Bittamleek, a (reasonable) period of time, between the lease contract and the time of the sale of the asset to the lessee, must have expired, to avoid ‘inah. This period must be long enough (one year as per the interpretation of MBL’s SSB) so that the leased property or its value could have changed.
Sale and Lease Back
Sale and Lease Back may be allowed in following cases: A. Financing of Newly Imported Asset (machinery, equipment etc) B. Replacement from Conventional to Islamic Financing
(for detailed process flow, see PDSC Policy # 25 dated December 16, 2005)
Sale and Lease Back
A. Financing of Newly Imported Asset • In cases where the Customer has already opened an LC through another Bank (without Agency Agreement) and requires funds to retire the LC alongwith Islamic Lease financing from MBL, SLB mechanism may be used. • Here it is important to note that the imported asset belongs to the Customer and not to that Bank, because in this case the LC opening Bank has just acted as an agent for the Importer • Therefore, in order to lease the asset, MBL needs to purchase the asset from the Customer.
Sale and Lease Back
B. Replacement from Conventional to Islamic Financing
• In cases where the Customer has taken interest based loan / lease through a Conventional Bank and wants to replace / switch his liabilities with Islamic Leasing due to Shariah reasons, SLB mechanism may be used. • In these type of cases the concerned Relationship Manager & Branch Manager / Corporate / Commercial Head should verify the genuineness of the transaction and ensure that the funds thus generated must be used to settle the outstanding Conventional loan/lease. • In this case specific approval of the Shariah Advisor must be obtained before credit approval and offering the facility to the Customer.
Sale and Lease Back
Sale and Lease Back is not allowed for Financing of Old Assets i.e. already acquired.
Any deviations from the SLB transactions defined above would require separate approval from the Shariah Advisor alongwith the process to be followed.
Ijarah Documentation Letter of Agency Undertaking to Ijarah Ijarah Agreement • Description of the Ijarah Asset • Schedule of of Ijarah Rentals • Receipt of Asset • Demand Promissory Note Undertaking to Purchase Ijarah Asset Sale Deed
Sequence Documents Letter of Agency
Undertaking to Lease
Undertaking to Purchase Sale Deed
Ijarah Documentation • In case the asset requires some time for erection/installation time, the rentals will start after the asset is in a useable condition. • Total cost of the asset must be determined at the time of execution of the Lease Agreement and will include all ownership related costs (such as duties, taxes, transportation etc.) • The rentals for the first period must be fixed at the time of execution of Lease Agreement and will remain fixed till the first rental revision date
Practical Issues • Expenses such as Import duties, taxes etc are not added to the total Cost of the Asset. • Where client himself arranges Insurance: No Insurance Agency agreement is executed with the Client Insurance expense is not reimbursed to the Client. • In case of loss/damage, the insurance claim received is shared with the client although the client has no right to claim such benefit.
Practical Issues • Sale & Leaseback transactions: Sale agreement must be executed before entering should into be a Lease time agreement. lag There the between
execution of two agreements. Asset cannot be sold back to the client before one (1) year passes.
Practical Issues • Lease Rentals start only after the asset is fully installed and becomes operative in nature. In cases of import of asset via Usance LC, rental should not be delayed till the actual outflow of funds from the Bank. • At the time of maturity or early termination of Lease agreement, a Sale deed must be executed to effect transfer of ownership.
Application • For long and medium term fixed asset financing like plant, equipment, generators etc. • Retail products like Car financing, Durable financing, Home Financing
Unique Selling Proposition • Pakistan’s first truly Shariah-compliant Car Financing Scheme. • • Available in tenures of 3, 4 and 5 years. Available for locally assembled as well as Imported cars. • • Also available for Used Cars No application Fee
Ijarah Financing for Assets Imported via Sight LC
Import Ijarah • The Importer opens the LC as an agent of the Bank. • The Importer places order with the foreign supplier on behalf of the Bank. • Upon receipt of documents the Bank makes payment to the foreign supplier. • The bank will enter into an Ijarah agreement with the customer.
• A specified rental will be agreed at this point in time. However, rental would be charged once the asset becomes workable in nature. • After the term of Ijarah agreement is completed, the bank may sell the asset to the importer at an agreed price.
Ijarah Financing for Assets Imported via Usance LC
• After necessary approvals, MBL and the customer enters into an Ijarah Agency Agreement listing the assets to be imported . • Under Ijarah agency, MBL appoints the customer as its agent to import the asset and pay relevant duties, taxes, transportation, and other charges to port authorities for releasing the asset. • All such payments made by importer shall be reimbursed by MBL and will constitute part of total cost of the asset.
• The customer provides an ‘Undertaking to Lease’ for taking the asset on Ijarah, once the asset is installed and becomes usable in nature . • The customer now opens a Usance LC under Ijarah agency from Meezan Bank counter. • Upon arrival of the import documents, the bank delivers the documents to the customer (acting as bank’s agent) as per the normal checking & acceptance process.
• The customer takes delivery of the asset as bank’s agent and pays the applicable duties and taxes etc. • At the time of execution of Lease agreement, forward cover is taken to fix the cost of the imported goods in PKR. • For determination of the rentals for the first period (usually 6 month), profit rate will be estimated based fixed. on the respective Benchmark rate (like KIBOR) and rentals for the first period will be
• The fixation of rent will not be delayed till the outflow of funds from the bank. • After installation of asset, MBL and the customer enters into an Ijarah Agreement and the lease rentals starts from the following month. • In case the asset requires some time before it becomes operative/workable, a grace period will be given and the rentals will commence after its installation.
What types of financing modes are possible for financing of following assets/goods: ( Murabaha, Ijarah or Dim Musharakah)
Car Generator Cotton Factory Rice Oil Machinery Yarn House Salary