Ijarah Muntahia Bittamleek (Rent-to-Own Finance Agreement)

Overview

Ijarah Muntahia Bittamleek (Ijarah) refers to a finance lease that includes a promise by the lessor to transfer the ownership in the leased asset to the lessee, either at the end of the duration of the rental period or in stages throughout the course of the rental agreement.

An Ijarah agreement is one whereby a party (Lessor), often a financial lending institution, finances property (Rental Asset) for the benefit of another party (Lessee), often a client, in return for mutually agreed fixed periodic rental instalment amounts (Rent).

An Ijarah agreement may operate as a mode of finance in accordance with Islamic finance principles, law and jurisprudence (فقه‎) and Sharīʿah (‘‎شريعة) standards (Islamic Law).

This article summarises herein:

(a)        our observations as to how the Ijarah mode of finance tends to be structured, and how it tends to operate, in Australia; and

(b)       what we have observed to be the principles and customary characteristics fundamental to a typically constructed Ijarah agreement in Australia (the Principles), and as such, this article is to be interpreted as nothing beyond our observations based upon on our professional dealings in Ijarah transactions and Islamic finance generally.

The Principles have regard to, and are prepared in accordance with, the Shari’ah (‘‎شريعة) standards as maintained by the Accounting and Auditing Organisation for Islamic Financial Institutions (the Standards).

Adaptation of Principles

The Principles have been necessarily adapted, for the benefit of those individuals of Muslim faith (المسلمون) adhering to Islam who are seeking finance, for the purposes of enabling access to a mode of finance that simultaneously:

(a)       complies with the Standards;

(b)       complies with the Australian legal framework; and

(c)        attempts to neutralise, or at least mitigate, the extent of compromise and disadvantage to the wealth and financial interests of such Muslims seeking finance (e.g. triggering double stamp duty) caused solely and directly through the course of complying with Islamic Law obligations, (the Fundamental Client Objectives).

While it is acknowledged that such adaptations involve exercising a reasonable level of indulgence with respect to the way in which the Standards are interpreted and applied, such indulgence:

(a)       is only to the extent necessary in order to reasonably neutralise, or at least mitigate, the extent of compromise and disadvantage to the wealth and financial interests of such Muslims seeking finance caused solely and directly through the course of complying with Islamic Law obligations;

(b)       reflects the absolute limit in terms of indulgence that may be exercised in order to still comply with the Standards and adhere to the spirit of the Standards;

(c)       notwithstanding the preceding sub-paragraphs, satisfactorily balances the need to maintain an appropriate level of integrity in terms of complying with the Standards; and

(d)      adheres with the fundamental spirit and essence of the Standards.

This article has been prepared in collaboration with an accredited specialist academic and expert in the field of Islamic Law, and its purpose is to summarise, and draw attention to, key principles and customary characteristics fundamental to an Ijarah agreement mode of finance when applied in the context of the Australian legal framework.

This article is not intended to be a comprehensive review of all potentially relevant legal or commercial issues relating to any particular transaction or type of transaction.

Lease Arrangement

An Ijarah agreement gives rise to a leasing arrangement on such terms whereby:

(a)       the Lessor purchases the Rental Asset (Initial Acquisition) for a price (Purchase Price) at the Lessee’s request;

(b)      upon completion of the Initial Acquisition, the Lessor then leases the Rental Asset to the Lessee for a period as agreed upon between the parties (Rental Period); and

(c)       in consideration for:

              (i)      being leased the Rental Asset; and

              (ii)     obtaining the exclusive right to peacefully possess, enjoy, improve, develop, enhance, modify and control the Rental Asset, the Lessee agrees to pay the Rent to the Lessor (Secured Money).

Effective Trust Settlement

Upon completion of the Initial Acquisition, the Lessee is typically to be transferred legal title in the Rental Asset to be held effectively on trust as trustee for the benefit of the Lessor (who is the beneficial owner of the Rental Asset) for the duration of the Rental Period and, to avoid doubt, until the particular Ijarah Agreement has completed and/or has expired (Effective Trust).

Wakalah

(a)        It is agreed by the parties that, as an essential term of an Ijarah agreement, the Lessor appoints the Lessee as:

(b)       the Lessor’s agent in respect of the Rental Asset; and

(c)        the custodian of the Rental Asset, for the Rental Period, and the Lessee consents to such appointment.

Duration

The Lessee must pay to the Lessor the Secured Money in full upon or prior to the Rental Period concluding.

Accordingly, throughout the Rental Period, the Effective Trust shall continue until the Lessee:

(a)       pays the Secured Money to the Lessor and the particular Ijarah Agreement has completed and/or has expired; or

(b)       the particular Ijarah agreement is otherwise terminated.

Rent

The Lessor is conferred with the right to charge Rent to the Lessee throughout the Rental Period, and Rent may comprise of both the Purchase Price and any fixed (not variable) profit.

Accordingly, through the course of the Lessee paying the Rent, the Lessee effectively reimburses the Lessor an amount equal to the Purchase Price in addition to paying the Lessor any profit (if applicable).

Customarily, Rent comprises of all fees charged by the Lessor in relation to leasing the Rental Asset to the Lessee (Fees).

Customarily, and for the purposes of avoiding doubt, Rent is clearly expressed throughout an Ijarah agreement in all the following forms concurrently:

(a)       in such a way that the underlying Fees are clearly particularised;

(b)       as a fixed periodic rental instalment amount; and

(c)       as a total amount for the duration of the Rental Period.

Shared Rates

Notwithstanding that, in accordance with Islamic Law, the normal position with respect to the payment of taxes, excise, stamp or other duties, imposts, deductions, charges, withholdings, rates, levies or other governmental impositions imposed etc assessed or charged in relation to the Rental Asset (Rates) is that they are to be shared between the parties, it is customary for the terms of an Ijarah agreement to provide that the Lessee is solely responsible for such Rates.

Alternatives to Effective Trust

Through the course of the Effective Trust being established, the transfer of legal title in the Rental Asset to the Lessor may give rise to duties, capital gains tax, and/or other liabilities, and therefore potentially render the commerciality of such transaction unviable.

Further to securing the Lessor’s rights, and the performance of the Lessee’s obligations, under an Ijarah agreement, including without limitation rights and obligations associated with the payment of the Rent outstanding, we have observed that a method applied to overcome this issue of viability is to incorporate essential terms into the construction of the Ijarah agreement effecting that:

(a)      a proprietary interest in the Rental Asset falling short of a declaration of trust is granted by the Lessee to the Lessor (Proprietary Interest); and

(b)      the Proprietary Interest is subsequently leased (back) by the Lessor to the Lessee for an associated fee partially comprising the Rent.

The intention behind such method is to avoid hindering fulfillment of the Fundamental Client Objectives, particularly in respect of maintaining the effectiveness and uncompromised integrity of the fundamental Ijarah agreement transactional components involving:

(a)      the Initial Acquisition (of the Rental Asset for the Purchase Price); and

(b)      the payment of Rent.

Gift Transfer Undertaking (Irrevocable)

At the end of the Rental Period and upon all Secured Money having been paid to the Lessor, the Lessee is entitled to be transferred ownership of the Rental Asset.

Accordingly, under an Ijarah agreement, it is typical for the Lessor to irrevocably undertake, as soon as reasonably practicable:

(a)      as at the end of the Rental Period;

(b)      upon all Secured Money having been paid to the Lessor; and

(c)      upon the Lessee paying the Lessor a token administration fee, to do all things and complete and execute all documents that are reasonably necessary to give full effect to:

(d)      the transfer of all its proprietary and beneficial right, title and interest in the Rental Asset to the Lessor; and

(e)      in accordance with paragraph (d) above, effect the discharge of the Proprietary Interest (and effectively nullify any lease arrangements in place with respect to such Proprietary Interest),

by way of gift and free of all encumbrances (Gift Transfer).

Completion and Expiry

An Ijarah Agreement is deemed complete and shall expire with immediate effect upon completion of the Gift Transfer