Usufruct: tradable commodity in Shariah

Our last week's discussion centred around the situation in which the lessee of an asset is permitted under Shariah to sub-lease the asset back to the asset-owner at an agreed upon lease rent provided that both rentals are paid on spot basis. This is to avoid the transaction from resembling Bay Al Inah or interest-based transaction where the leasing of the asset is used as Heela or cover up.

This could be an extraordinary situation where the owner, having already leased the asset, may need to re-possess the same due to some reason and not being able to terminate the lease, will seek the lessee to lease back the asset to it. In the normal course, sub-leasing plays important role in Islamic finance.

In fact the usufruct or Manfa'a (the right to use an asset) is regarded as commodity in Sharia which can be traded. Sub-leasing of an asset by the first lessee is effectively the indulgence in trading of the usufruct.

Sub-leasing contracts can be entered into for an asset which is identified and existing, as well as for an asset which needs to be built. In latter case, the parties will enter into a forward sub-lease contract. The parameters for entering into a forward leasing contract have earlier been discussed in this column.

There are occasions when a customer does not seek the Islamic financial institution (IFI) to use 100 per cent of its equity in purchasing the asset which the customer wants to lease from IFI. It would rather like to contribute certain amount towards the purchase price.

In such a situation, Shariah permits IFI and customer to jointly purchase the asset by entering into Sharikat-Melk or co-ownership contract, representing joint ownership of the asset.

Usual terms

The Shariah-compliant mechanism usually adopted for entering into such transactions is for the IFI and the customer to sign a Sharikat-Melk contract which includes the objectives of the transaction, equity contribution by both parties, ascertaining the joint ownership ratios, period of contract and the other usual terms.

Preferably the IFI and customer should purchase the asset in their joint names, however, if needed the Shariah allows the IFI to appoint the customer to represent both parties in purchasing the asset. It enables the customer to conclude the purchase transaction with the seller of the asset in its name but for and on behalf of both parties ie itself and the IFI.

In order to protect its ownership interests, IFI may ask the customer to execute a declaration of trust document in favour of IFI, stating that although the registered title is held with the customer, the asset is also partly owned by the IFI.

Once the asset has been purchased, the IFI may lease its part of the jointly-owned asset to the customer by way of entering into a separate lease agreement. In most of the cases that I have come across, the leasing of a jointly owned asset is carried out under the Ijara Muntahiyya Bittamleek (or financial leasing) basis whereby upon completion of the lease term, the asset ownership is transferred to the lessee in full. In such leasing arrangement the periodical rental is structured in a manner that the customer as lessee pays out the IFI's entire cost of partly owning the asset.

(to be continued)

The writer is the vice-president and head of Shariah structuring, documentation and product development at Dubai Islamic Bank.