legal guide09.indd - Islamic Finance News

Transportation Finance (continued..)
to be set up to own the asset. As with a conventional
structure, the SPC requires funds to acquire the
asset. However, unlike a conventional structure, the
SPC is not able to enter into a loan agreement with
the Islamic financier as an interest-bearing loan is
not Shariah compliant.
However, the Islamic financier may enter into a
Mudarabah agreement with the SPC. In general
terms, the Mudarabah agreement involves investors
(being the Islamic financiers) providing funds to the
mudarib. The mudarib holds itself out as having skill
and expertise in a particular area.
The Islamic financier will advance funds to the
mudarib so that the mudarib can employ those funds
in a Shariah compliant manner to generate a profit
for the Islamic financier. In a standard asset finance
transaction, the mudarib agrees in the Mudarabah
agreement to use the funds to acquire a specific
ship/aircraft. The customer leases the asset through
an Ijarah.
In return, the mudarib receives a small percentage
of the profits. The mudarib is not responsible for
any losses, unless such losses are caused by its wilful
misconduct or gross negligence. It is important to
note that the mudarib does not guarantee that it will
generate a profit, as this is not Shariah compliant. In
addition, its obligations are limited recourse; limited
to proceeds it receives from the customer pursuant
to the Ijarah.
Whilst there are many similarities between
conventional finance lease and Islamic operating
lease financing, there are also some key differences.
The main difference is that the legal owner of the
asset must bear certain risks associated with owning
such asset. In a conventional structure, many of
these ownership-related risks are passed through to
the customer under the conventional finance lease.
Accordingly, a conventional lessor retains minimal
ownership obligations. However, under an Ijarah, it
is not permissible for ownership-related obligations,
and the financial consequences arising thereunder,
to be transferred to the customer. In summary, these
obligations are:
• obligations relating to ownership/
proprietorship taxes;
• obligations relating to major maintenance
activities (for example, major maintenance
checks); and
• obligations relating to insuring the asset.
The costs and risks associated with these obligations
can be very significant. To address this, arrangements
have been developed whereby these obligations
are performed by the customer acting as the
servicing agent of the owner. The parties achieve
this by entering into a servicing agency agreement.
Accordingly, the customer (as servicing agent) is
responsible for performing the relevant obligations.
The servicing agency agreement will state that the
servicing agent will indemnify the owner for any
default in the performance of these obligations.
There will also be a provision in the Ijarah stating
that a breach of the service agency agreement by the
servicing agent will trigger an event of default under
the Ijarah. This then allows the owner to terminate
the leasing of the asset.
Under general Islamic principles, a servicing agent
must be compensated for any costs properly incurred
by it on behalf of the owner. This means that the
owner must reimburse the servicing agent for those
expenses that it incurs in relation to the provision of
such services.
However, so that the risk/reward matrix is the same
as a conventional structure, the amount to be paid
by the owner to the customer (as servicing agent)
is paid by the customer (as lessee) to the owner
(as lessor) as additional rent under the Ijarah. The
documentation will provide that such payments will
be made on the same date and will be netted off.
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