Professional Documents
Culture Documents
Legal Aspect of Islamic Finance
Legal Aspect of Islamic Finance
LAW- M605
Table Of Contents
1. Introduction
5
6
6
4.1. Introduction.
10
11
7. Conclusion
12
8. Bibliography
13
9. Appendix A
14
1. Introduction
It has to be conceded that Islamic financing is one of the most accelerated growing industries in the
field of global banking and financial systems during the last three decades. 1 Beginning with Dubai
Islamic Bank which was founded in 1975, nowadays there are more than 300 global institutions
specializing in Islamic financing across the world. The assets of these institutions are approximately
$250 billion with estimated growth at 10-15 percent per annum. 2 This unparalleled growth was no
coincidence. There are many factors contributing to this soaring growth, such as the continued
prosperity in the middle east states in respect of oil wealth, an increased desire among Muslims to
elicit financial services that meet the Sharia (Islamic law) requirements, and the attractiveness of the
Islamic financing products which are appealing to both Muslim and non-Muslim investors. 3 It is
worth mentioning that Islamic financing is not merely confined to the Middle East or to Islamic
countries only, but also, it is sought after, wherever there is a reasonable Muslim community
worldwide. 4
The aim of this essay is to advise The Islamic Bank of Transylvania (IBT), which has recently founded
an Islamic bank in the UK, regarding its intent to take a part in Ijarah (one of the Islamic financing
techniques) transaction with East Airlines (EA) for the purpose of purchasing four aircrafts which
currently are owned by Universal Airways (UA). This advice will draw attention to the pertaining
issues of Ijarah transaction including the intrinsic elements which Ijarah contract contain for the sake
of eliciting the approval of Sharia (Islamic law) Supervisory Board. Also, it will shed light on the
number of legal risks that IBT may encounter during the Ijarah transaction, and to what extent such
risks could be diluted.
Faisal Attia,'Do the distinctive features of contemporary Islamic finance lie in its form or substance' (2008) Butterworths
Journal of International Banking and Finance Law 599
2
Juan Sol,' Islamic Banking Makes Headway' (2008) IMF Survey Magazine
3
M El-Qorchi, Islamic finance gears up (2005) 42 finance and development 46
4
Alsadek H. Gait and Andrew C. Worthington, 'primer on Islamic finance: Definitions, sources, principles and
methods'(2009) Islamic Finance
< http://www.business.uq.edu.au/download/attachments/31293547/150_Gait_paper.pdf> accessed 4 January 2010
3
2.1. Definition
The term 'Islamic Financial system' could be defined as 'a financial service principally implemented
to comply with the main tenets of Sharia'. 5 Sharia in turn is derived primarily from four sources.
First, Quran (the sacred book of Islam) which is consisted of God revelations to Prophet Muhammad.
The bulk of Quran legal verses are none detailed. Second, Sunna which is comprised of the sayings,
practices and approvals of Prophet Muhammad (May peace be upon him) during his lifetime. The
third source is Ijma (consensus) which refers to the consensus of the whole religion scholars on a
particular subject in the era of the ages. The last main source of sharia is Qiyas (analogical
reasoning). Qiyas is the process of analogical reasoning that aim to provide a legal opinion upon a
new case, which is not referred to in previous sources, by comparing it to other refereed cases which
have the same effective reason. 6 These authentic sources draw the big picture of the Islamic law.
2.2. The Features of Islamic Financing
The Islamic financing framework, at present, has several numbers of characteristics which may be
unique in its field. These qualities could be summed up in three prime attributes. First, Money is
exclusively a medium of exchange. The concept of money, within Islamic financing system is merely
a mean of exchange. Therefore, it is forbidden, in general, under Islamic law to use money as a
subject matter of trade. In other words, making profit through trading in money is not allowed in
sharia, because money in essence is lacking of genuine value. 7 Second, asset-backed financing. One
of the intrinsic qualities which characterizes the Islamic financing system is that, it is an asset backed
financing. On the contrary of the conventional system which is dealing merely in money and
monetary papers, Islamic financing framework is often grounded on non-liquid assets. The core of
any Islamic financing transactions must be something that has a genuine utility. 8 Third, Islamic
financing is concerned with ethical investment. The Islamic financing lays a particular stress on the
5
Alsadek H. Gait and Andrew C. Worthington, 'primer on Islamic finance: Definitions, sources, principles and
methods'(2009) Islamic Finance http://www.business.uq.edu.au/download/attachments/31293547/150_Gait_paper.pdf>
accessed 4 January 2010
6
Faisal Attia, Introduction to Islamic Finance (University of East Anglia, Norwich 2009) also, Alsadek H. Gait and
Andrew C. Worthington, 'primer on Islamic finance: Definitions, sources, principles and methods'(2009) Islamic Finance
7
Faisal Attia,'Do the distinctive features of contemporary Islamic finance lie in its form or substance' (2008)
Butterworths Journal of International Banking and Finance Law 599
8
M Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002) p xiv.
4
fairness of trade. Thus, any transactions containing unethical criteria such as deception,
circumventing and monopoly are invalid and not compliant with Islamic law because of the
contradiction of such criteria with the overall tendency of Islamic law to achieve social justice and
fair economic prosperity. In addition, in spite of the inducement of Islam to achieve the economic
wellbeing, sharia differentiates clearly between the acceptable commercial activities and those that
are, unacceptable from the Islamic point of view. For example, commercial activities involving
alcohol, pork and its products, armaments, gambling...etc are certain to be void within Islamic
financing system because it is basically forbidden under sharia. 9
Michael Ainley and others,' Islamic Finance in the UK: Regulation and Challenges' [2007] The Financial Services
Authority.
10
Hussam Musa, Saleh M. and Obadi, 'Islamic financial systems'(1997)34 Finance and Development 42,45 also, Faisal
Attia, 'Do the distinctive features of contemprary islamic finance lie in its form or substance' (2008) Butterworths Journal
of International Banking and Finance Law 599
5
The prohibition of Gharar (extreme uncertainty) sales could be seen clearly through considerable
number of Sunna. The concept of Gharar refers to the sale of probable items whose existence or
characteristics are not certain, due to their risky nature, which makes the trade similar to gambling.11
This uncertainty could be arisen as a result of lacking of vital information in a contract12 for example,
it was mentioned in the following Sunna by Ahmad and Ibn Maajah narrated on the authority of Abo
Saeed Alkudry mAbpwh :
The Prophet Pbuh has forbidden the purchase of the unborn animal in its mother's
womb, the sale of the milk in the udder without measurement, the purchase of
spoils of war prior to their distribution, the purchase of charities prior to their
receipt, and the purchase of the catch of a diver. 13
The main reason for prohibiting these sales, mentioned above, is the high level of ambiguity or
uncertainty which is inherent in such sales. Furthermore, in some of these sales the purchaser does
not have the slightest idea what he would obtain. However, in contrast to Riba, a considerable
number of Islamic scholars have permitted some of the contracts which include Gharar, provided that
this Gharar is minor.14They maintain that there is no contract that is totally detached of any level of
Gharar. Thus, they have differentiated between major Gharar and minor Gharar in the validity of the
contract or not. Based on this distinction, the Fatwa (a legal opinion by an Islamic scholar) in this
field may vary from one scholar to another, in a certain issue15.
2.3.3. Third, Prohibition of Maysir (Gambling)
"Maysir" has been explicitly forbidden in the Holy Quran and the Sunna. Given the risky nature of
gambling which may result adverse consequences for one of the parties at the expense of the other,
Islamic law perceives Maysir as an unacceptable vanity attitude and way to make money. Hence,
Islamic financing system considers any contemporary transactions that highly depending on chance,
not effort or crafts as unequivocally contrary to Sharia16. But, likewise Gharar, the fatwa about a
specific transaction is likely to be different from one scholar to another.
11
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance (2000) Rice University, Houston.
Faisal Attia, 'Do the distinctive features of contemprary islamic finance lie in its form or substance' (2008)
Butterworths Journal of International Banking and Finance Law 599
13
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance (2000) Rice University, Houston.
14
A Al-Saati, The Permissible Gharar (Risk) in Classical Islamic Jurisprudence (2003) 16 Islamic Economics 3.
15
Faisal Attia, Sharia Financial Prohibitions,(University of East Anglia, Norwich 2009)
16
M Iqbal and P Molyneux, Thirty Years of Islamic Banking: History, Performance, and Prospects (New York, Palgrave
Macmillan, 2005) also, Faisal Attia, Sharia Financial Prohibitions,(University of East Anglia, Norwich 2009)
12
3. The General Conditions of The Sale Contract in the Islamic Financing System.
It is a matter of importance to the Islamic Bank of Transylvania to be familiar with the principles of
the Islamic sale contract as it will take a part in sale agreement with UA. Unlike conventional sale
contract, Islamic law lays great emphasis on several numbers of conditions which must be fulfilled in
any sale contract to comply with sharia. These conditions could be summarised in six prime
conditions. First, the merchandise must be owned by the seller at the time of the contract (with some
exceptions). Second, the contract of sale must be immediate and final. Third, the merchandises must
be precisely identified. Otherwise, the contract will be considered as major Gharar, which is
forbidden under Islamic law. Fourth, the sale price must be certain. Furthermore, the price of the sale
become immutable once it is fixed. Fifth, the commodity of sale must have a value from an Islamic
perspective. Merchandises such as alcohol, pork related products...etc are Haram (forbidden by
Islamic law) and have no value under sharia. The sixth condition, the commodity should not be used
for forbidden purposes such as armaments. 17
If any contract of sale fails to meet one of these conditions, it is then almost certain to be void under
Islamic law. It is, therefore, should be recommended that IBT should make sure, in advance, that its
contract with UA has abided the conditions of the sale contract according to Islamic financing
system.
17
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance (2000) Rice University, Houston. Also,
Faisal Attia, 'Do the distinctive features of contemprary islamic finance lie in its form or substance' (2008) Butterworths
Journal of International Banking and Finance Law 599
Ijarah occupies a prominent place in Islamic financing industry. Interestingly, it would serves as a
technique of financing as well as a form of investment in Islamic financing system. In essence, the
Ijarah, which lexically means 'give something on rent', is a normal commercial activity equivalent to
sale. But, in the contract of Ijarah what is in sale is not the asset; it is the usufruct (the temporary
right to use and profit from the object) of the asset for a definite period. 18 Islamic law has approved
the sale of usufruct as evidenced in a number of the verses of the holy Quran and Sunna.
4.2. Ijarah as a financing technique.
The contemporary evolution of the concept of the Ijarah contract as a means of investment, into a
means of financing occurred due to certain reasons. In fact, this evolution has emerged discernibly in
the western countries through the tendency of some financial institutions to devise an Islamic
alternative of giving an interest-bearing loan. They leased some types of object to their customer for
a fixed amount, payable monthly, for a definite period. This amount, in effect, encompasses the
actual cost of this object plus the stipulated interest. At the end of the leasing period, the ownership
of the object transferred directly to the lessee (the customer). 19 This innovative technique so-called '
ijarah wa iqtina ' (lease ending with ownership) in Islamic financing industry.
18
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance (2000) Rice University, Houston. also,
M Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002)
19
M Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002)
20
Faisal Attia, Ijarah(lease),(University of East Anglia, Norwich 2009)
8
21
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance (2000) Rice University, Houston. , M
Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002) and Faisal Attia,
Ijarah(lease),(University of East Anglia, Norwich 2009)
22
Faisal Attia, Ijarah(lease),(University of East Anglia, Norwich 2009)
9
Second, unlike conventional financial leasing, under Islamic law, IBT would endure the risks and
consequences of any loss or damage that might occur for the aircrafts during the period of Ijarah.
This risk could be mitigated and contained comprehensively by arranging Takaful (Islamic
insurance) protection for the aircrafts. The cost of this insurance could be added to the monthly rent.
Third, according to Islamic rules of Leasing, any liabilities related to the ownership of the aircrafts
are born by IBT (as it is the lessor). Thus, IBT will be incurred to pay for the liabilities of the
aircrafts, such as the aircrafts taxes, during the leasing period. Once again the cost of these liabilities
could be calculated and added to the monthly rent. Forth, in order to avoid any inadvertent default in
characterisation by which IBT may fail in purchasing the exact aircrafts which have been specified
by EA, IBT should purchase the aircrafts through EA. In other word, EA will buy the aircrafts on
behalf of IBT who pays its price (50 million US$) to Universal Airways (the supplier). This approach
could be compliant with sharia provided that, the period of the lease starts after the EA has taken
delivery of the aircrafts, and not from the day of purchase of aircrafts by the IBT. 23
However, to elicit the support of Sharia Supervisory Board, it is of the utmost importance that IBT
follows precisely the Ijarah wa-iqtina structure as set out below.
5. The Structure of Ijarah Wa-Iqtina in Islamic Financing System.
The Structure of Ijarah Wa-Iqtina in Islamic Financing System could be divided into three basic
stages.24 First stage, The EA will offer Wa'd (one-sided binding promise) through which the EA
promises to lease the aircrafts from IBT for a definite period and a specific rent, once the aircrafts are
owned by IBT. Second stage, In the light of the EA Wa'd, The Islamic bank (the branch of IBT in
London) will arrange for an agency agreement by which the EA will draft a normal sale agreement
with universal Airways (the supplier) on behalf of IBT who will pay its price (50 million US$).
Notably, this sale agreement must satisfy the general conditions of the sale contract in Islamic
financing system. Third stage, after the IBT have completely owned the four aircrafts, it can draft an
Ijarah Wa-Iqtina agreement with EA. 25 Significantly, this lease agreement must abide with the rules
of Islamic leasing.
23
M Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002) also, Faisal
Attia, Ijarah(lease),(University of East Anglia, Norwich 2009)
24
Please see Figure 1 in Appendix A.
25
Taqi Usmani, An Introduction to Islamic Finance (The Netherlands, Kluwer Law International, 2002) and Faisal Attia,
Ijarah(lease),(University of East Anglia, Norwich 2009)
10
26
The Rome Convention is the Convention on the Law Applicable to Contractual Obligations and it opened for signature
in Rome on 19th June 1980.
27
Please see Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others [2004] 4 All ER 1072
28
Vogel F., Islamic law and legal system: studies of Saudi Arabia (Brill Academic Pub,2000) p xi
11
7. Conclusion.
This assay has briefly explored the nature of the Islamic financing system in order to provide a
comprehensive advice to The Islamic Bank of Translavia on its intention to engage in Ijarah
transaction with East Airlines. Also, it has knocked on all relevant issues of the concept of Ijarah as
an Islamic financing technique, including its definitions, conditions, Structures and risks which are
inherent in Ijarah transaction. Furthermore, It has shed some light on the appropriate wording of the
choice of law on Ijarah Transaction, which is corresponding with English law.
12
BIBLIOGRAPHY :
Faisal Attia,'Do the distinctive features of contemprary islamic financing lie in its form or
substance' (2008) Butterworths Journal of International Banking and Financing Law
Michael Ainley and others,' Islamic Financing in the UK: Regulations and Challenges' [2007]
The Financial Services Authority .
Hussam Musa, Saleh M. and Obadi, 'Islamic financial systems'(1997)34 Financing and
Development
M El-Gamal, A Basic Guide to Contemporary Islamic Banking and Financing (2000) Rice
University, Houston.
M Iqbal and P Molyneux, Thirty Years of Islamic Banking: History, Performance, and
Prospects (New York, Palgrave Macmillan, 2005) also, Faisal Attia, Sharia Financial
Prohibitions,(University of East Anglia, Norwich 2009)
Juan Sol,' Islamic Banking Makes Headway' (2008) IMF Survey Magazine
Shamil Bank of Bahrain EC v Beximco Pharmaceuticals Ltd and others [2004] 4 All ER 1072
13
Appendix A
- Figure 1
The
BANK
IBT's branch in London
The Customer
(IBT)
East Airlines Company
1. Wa'd to Lease
Ijarah Wa-Iqtina contract. 4
2. Agency Agreement
3. Sale Agreement
The Supplier
(IBT)
Universal Airways
Company
14