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Variable Rentals in Long Term Leases (
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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
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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 )
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 )
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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