Lease



Like Murabaha, a lease was not originally a mode of finance. A lease is simply a transaction meant to transfer the usufruct of a property from one person to another for an agreed consideration. However, certain financial institutions have adopted the use of leasing as a mode if financing in place 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 transactions have been dispensed with.

When interest-free financial institutions were recently established, they found that leasing is a recognized mode of financing throughout the world. On the other hand, they realized that leasing is a lawful transaction according to the Shariah and it could 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 form of leasing agreements as were in vogue among the traditional financial institutions without any modification although a number of their provisions were not in conformity with Shariah.

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 word 'interest' by the word 'rent' and replace the word 'mortgage' by the word 'leased asset'. There must be a substantial difference between leasing and an interest - bearing loan. A clear distinction will be possible by following all the Islamic rules of leasing some of which have been mentioned in the first part of this article.

To be more specific, some basic differences between contemporary financial leasing and the actual leasing allowed by the Shariah are indicated below.

1. The commencement of the lease
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 taken delivery of the asset. This is not allowed in the Shariah because it amounts to the charging on the money given to the customer which is simply nothing but pure interest.

The correct way according to Shariah would be 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 will not be liable for the rent for the period of delay.

It should be clearly kept in view that when the lessee himself has been entrusted with the purchase of the asset intended to be leased, there are two separate relationships 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 behalf of the institution. At this stage the relationship between the parties is nothing more than the relationship of a principal and his agent. The relationship 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 relationship of lessor and lessee comes into existence.

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 obligation of a lessee. In this period he is responsible to carry out the functions of an agent only. However, when the asset is delivered to him, he is liable to discharge his obligations as a lessee.

There is a difference between murabaha and leasing. In murabaha, as mentioned earlier, the actual sale takes place after the client takes delivery from the supplier and the previous agreement of murabaha is not sufficient 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 to make an offer for the purchase from it and the sale takes place after the institution accepts the offer.

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

There are two reasons for this difference between murabaha and leasing:
Firstly it is a necessary condition for a valid sale that it should be effected instantly. Therefore, a sale attributed to a future date is invalid in Shariah. But leasing can be attributed to a future date. Therefore the previous agreement is not sufficient in the case of murabaha while it is sufficient in the case of leasing.

Secondly, the basic principle of Shariah is that one cannot claim a profit or fee for a property the risk of which has never been borne by him.

Applying this principle to murabaha, the seller cannot claim a profit over a property which never remained in 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 risk of the seller even for a moment. That is why the simultaneous transfer is not possible in murabaha and there should be fresh offer and acceptance after the delivery.

In leasing, however, the asset remains in the risk and ownership of the lessor throughout the lease period because the ownership ahs 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 above.

2.Expenses

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 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, custom duty et. He can, of course, include all these expenses in his cost and can keep them in view 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 Shariah.

3. 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 for the wear and tear which normally occurs during its use. However, the lessee cannot be made liable for a loss caused by factors beyond his control. The agreements of traditional 'financial leases' generally do not differentiate between the two situations should be dealt with separately.

4. Termination of Lease

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 'finance 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 discretion. This is again contrary to the principle of Shariah.

5. Rent on Termination of the Lease

In some agreements of the 'finance lease' a condition is incorporated to the effect that in case of the termination of the 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 Shariah 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 consequences of a lease contract.

Naturally, such a condition cannot be acceptable to the Shariah. The logical consequence of the termination of the lease is that the asset should be taken back by the lessor. The lessee should be asked to pay the rent due to up to the date of termination. If the termination has been effected due to the misuse or negligence on 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 for the remaining period.

6. Insurance of assets

If the leased property is insured under Islamic mode of takafful, it should be at the expense of the lessor and not at the expense of the lessee, as is generally provided for in the agreements of the current 'financial lease'

7. Sub-lease and assigning of the lease

The lessee cannot sub-lease the leased asset except with the express permission of the lessor.

8. Assigning of the lease

The lessor can sell the leased property to a third person whereby the relationship of the lessor and the lessee shall be established between the new owner and the lessee. However, the assigning of the lease itself 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. It is not allowed in Shariah.

These are some basic features of the 'financial lease' which are not in conformity with the dictates of Shariah. When using the lease as an Islamic mode of financing these shortcomings must be avoided.

The list of 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. An Islamic lease agreement must conform with all the basic principles.

Page last updated: 2019-10-17