Defining defaults in lease contracts

Once signed, the Ijara (lease) contract, will remain binding on the lessor and lessee and cannot be terminated or altered, unless consented to by both parties.

However, an Ijara contract may be terminated in special circumstances such as destruction of the leased asset beyond economic repair, due to lessee's negligence or any cause attributed to force majeure or occurrence of any of the agreed events of default by the lessee.

Events of default are listed breaches of the leasing arrangement, incorporated in the text of lease contract and are agreed to by the lessee.

Provided below are some of the events normally found in the lease contracts entered-into by an Islamic Financial Institution (IFI) as lessor with its customer as lessee:

i. Lessee's failure to pay the lease rent within certain number of agreed days from the due date;

ii. Lessee fails to comply with any other provision of the lease contract and continuation of such failure for a certain number of agreed days;

iii. Revelation upon lessor at any time during the lease period that a representation, warranty, covenant or undertaking made by the lessee at the time of entering into the lease contract was incorrect in any material respect;

iv. Lessee shall (a) be unable to pay any of its debts (including the lease rent) as they fall due, (b) apply for or consent to the appointment of a receiver, administrator or liquidator for its entity (c) be adjudicated or declared by any competent authority to be bankrupt or insolvent and such adjudication or declaration is not set aside within a short period, say 21 days;

v. An order, judgment or decree shall be entered by any court of competent jurisdiction for the liquidation, re-organisation, dissolution, winding up, or composition or readjustment of debts of the lessee;

vi. It becomes unlawful for the lessee to continue to perform or comply with any of its material obligations under the lease contract. Examples are non-renewal of the professional licence by an airline or shipping company, breach of exploration licence terms by an oil company, etc.

vii. Change in lessee's constitution or the ownership structure without lessor's consent;

viii. Total destruction of the leased asset due to lessee's mishandling or negligence.

An event of default is recognised under Sharia as an event the avoidance of which was very much within lessee's control.

There are other events which are beyond lessee's control. Some examples are change in regulatory environment by the government thereby impacting the validity of the lease contract, requisition of the leased asset by the government for its own use (a likely event in emergency and destruction of the leased asset beyond economic repair due to act of God, etc.

A leased asset would be deemed to suffer destruction beyond economic repair if the estimated cost to repair the asset exceeds its pre-damage economic value, rendering any repair work meaningless.

In Sharia, the treatment to events which are within lessee's control is different compared to the events which are beyond lessee's power to avoid. This is in contrast to a conventional leasing document where the odds are heavily staked against the lessee and no such differentiation is made.

This aspect of fairplay in Sharia has impressed large corporations the from GCC region who have recently opted for Islamic finance after having relied on conventional borrowings for decades.

(to be continued)

The writer is the VP and Head of Sharia Structuring, Documentation and Product Development, Dubai Islamic Bank.