Unlike conventional leases, ownership and liabilities remain with the lessor explains Emma Giddings
Following the recent World Islamic Economic Forum in London, interest has increased in the use of Islamic finance as a source of funding for the aviation and shipping industries, but is it possible to reconcile Sharia principles with the practical reality of operating ships and aircraft?
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Most Sharia compliant structures for the financing of aircraft and ships employ the use of an ijara (a Sharia compliant lease).
A straightforward ijara is equivalent to an operating lease whereby the economic owner of the asset is the lessor and the lessee is expected to return the asset to the lessor at the end of the lease term.
An ijara can be combined with separate sale and purchase undertakings to create an Ijara wa’iqtina. This is a lease akin to a finance lease whereby the economic owner of the asset is the lessee and the lessee group expects to purchase the asset on the termination or expiry of the lease.
Despite the similarity of an ijara to a conventional lease, the requirements of Sharia challenge the traditional allocation of risk and responsibility between lessor and lessee. In a conventional lease, the lessee usually assumes all of the risk associated with the operation of the asset – the lessee will be obliged to insure, maintain and repair the asset.
If the asset suffers a total loss, the lessee will be obliged to pay to the lessor an amount to compensate him for the loss of the asset by a given date, regardless of whether or not insurance proceeds have been received. The lessee will also indemnify the lessor against any liability which the lessor may suffer as a result of the lessee’s operation of the asset.
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By GlobalDataSharia offers an alternative view. In an ijara as the ownership of the asset is not transferred by the lessor to the lessee, the liabilities of the ownership of the asset remain with the lessor.
The lessor will remain responsible for obtaining hull insurances and for the performance of major maintenance and structural repair. In addition indemnities are often seen as a means of fault rather than risk allocation.
Yet in reality the airline or shipping company lessee will have existing insurance and maintenance arrangements for its fleet. Similarly the airline or shipping company lessee will maintain third-party liability insurances to cover operational risk and its exposure under any operational indemnity in its leases.
As a way of reflecting this commercial reality while at the same time adhering to Sharia principles, it has become common for the lessor to appoint the lessee as its service agent to obtain hull insurances and to perform major maintenance and structural repair to the aircraft or ship.
Although Sharia principles may appear to conflict with conventional notions of risk allocation between a lessor and a lessee, it is usually the case that solutions can be found to ensure transactions reflect practicalities as well as complying with Sharia and other relevant laws.
Emma Giddings is a partner with Norton Rose Fulbright
