TILBURG LAW SCHOOL LEGAL STUDIES RESEARCH PAPER SERIES

Structuring Sukuk al-Ijarah in the Netherlands

Omar Salah
Tilburg Law School Tilburg Institute for Interdisciplinary Studies of Civil Law and Conflict Resolution Systems (TISCO) o.salah@uvt.nl

TISCO Working Paper Series on Banking, Finance, and Services 08/2010 November 2010

Tilburg Law School Legal Studies Research Paper Series No. 07/2011

This paper can be downloaded without charge at TISCO Working Paper Series on Banking, Finance and Services, available at the Social Science Research Network http://www.ssrn.com/link/Tilburg-TISCO-Banking-Financing.html

Electronic copy available at: http://ssrn.com/abstract=1718384

Electronic copy available at: http://ssrn.com/abstract=1718384

Structuring Sukuk al-Ijarah in the Netherlands

Omar Salah O.Salah@uvt.nl

Abstract The Islamic banking & finance market is growing fast. With an annual growth of 15%, this sector seems much promising. Within the Islamic finance market, sukuk (Islamic securities) are arguably the most important Islamic financial products. Although several European countries are entering the market with success, the subject is still rather unknown in the Netherlands. This raises the question to the possibilities for sukuk in the Netherlands. The main focus of the study is to analyse the legal aspects of the sukuk al-ijarah structure under Dutch civil law. Adapting these instruments to the Dutch legal context requires a thorough understanding of sukuk and of its religious, legal, and transactional requirements. Through an interdisciplinary approach and a comparative study, this research will lead to more insight into Islamic financial principles and Islamic financial contracts, enabling the reader to understand sukuk structures and transactions. This study illustrates whether the sukuk al-ijarah can be structured under Dutch civil law, raising questions in regard to the fiduciaprohibition of section 3:84 (3) Dutch Civil Code, the concept of a trust under Dutch property law, and the certification of assets under Dutch civil law.

-1Electronic copy available at: http://ssrn.com/abstract=1718384

Structuring Sukuk al-Ijarah in the Netherlands1

Omar Salah2

1. INTRODUCTION

1.1 Introduction to Islamic finance market

Financial activities concerning Islamic finance have grown significantly in recent years. The Islamic finance sector shows a growth of 15% a year.3 Worldwide, there were 300 Islamic financial entities operating in 2006 with total assets counting over USD 300 billion and assets under management (AuM) counting USD 400 billion. Islamic financial products are also establishing a foothold in Europe. 4 The market for sukuk, worth USD 100 billion, seems promising.5 In 2004, Germany issued the first European-based and backed sukuk. The first Islamic bond in the United Kingdom (UK), issued by Dubai Islamic Bank and therefore also listed on the Dubai International Financial Exchange, was quoted on the London Stock Exchange (LSE) in March 2007.6 Since this first issue, new Islamic bonds have been issued nearly every month on the LSE. The demand for Islamic financial products appears considerable in the Netherlands as well, because the Netherlands is home to just under one million Muslims.7 Furthermore, some financial institutions are eyeing the market for Islamic financial services with interest. 8 However, Islamic financial products, and the issuance of sukuk in particular, are not known in the Netherlands. So the question arises to the possibilities of Islamic financial products such as sukuk in the Netherlands.

This paper is largely based on the draft of a book to be published by Wolf Legal Publishers in 2010: O. Salah, Islamic Finance: Structuring Sukuk in the Netherlands, Nijmegen: Wolf Legal Publishers. Publication date 2010. 2 PhD candidate at the TISCO research institute of the Private Law Department of Tilburg Law School (the Netherlands). The subject of his PhD research is Islamic finance. He is also affiliated with the law firm De Brauw Blackstone Westbroek. 3 DNB June 2007 4 Verhoef, Azahaf & Bijkerk 2008, p. 22 5 Schouten 2009 6 Verhoef, Azahaf & Bijkerk 2008, p. 22 7 Verhoef, Azahaf & Bijkerk 2008, p. 23 8 Verhoef, Azahaf & Bijkerk 2008, p. 23

-2Electronic copy available at: http://ssrn.com/abstract=1718384

1.2 Purpose of the study

The purpose of the research is studying the possibilities of the issuance of sukuk al-ijarah, a specific form of sukuk, in the Netherlands. This will be realised with a descriptive study. Understanding Islamic finance requires an interdisciplinary approach. The basic principles of Islamic finance are based on the ideas of Islamic economics. Therefore, an economic understanding of the subject is essential. Moreover, Islamic finance and Islamic economics both originate from Islamic law and, therefore, it is important to discuss the principles from a religious perspective. So in order to understand the basics of Islamic finance, Islamic law needs to be studied and, consequently, a theological approach of the subject seems ineluctable. Important and relevant studies on Islamic economics and Islamic law are in Arabic and Urdu, while studies on Islamic finance are mostly in English. Therefore, this research consists of a literature study of English, Dutch, German, (and translations of) Arabic, and Urdu sources. Once the basics of Islamic finance are clarified, the structures of sukuk need to be examined. The legal structures of sukuk are based on English concepts, so a study of these English concepts and of the structures of sukuk is important for a better understanding of the sukuk alijarah. As mentioned before, sukuk is unknown in the Dutch financial practice and, therefore, there is uncertainty in regard to the legal structure of this product under Dutch civil law. It is uncertain whether it is possible to structure the sukuk al-ijarah under the current Dutch civil law or whether legislative changes are needed. This research discusses the legal issues9 of the sukuk al-ijarah structure under Dutch civil law and clarifies the legal infrastructure of the sukuk al-ijarah structure.10 From a legal perspective the issuance of sukuk al-ijarah contains similarities with a (legal) securitisation-structure.11 In order to mark out the research, merely civil law aspects of the (legal) structure of the sukuk al-ijarah will be discussed.12

In order to mark out the research, legal issues such as the enforceability of the transactional documents, the choice of law, and enforcement of judgments will not be discussed in this research. 10 The choice for the sukuk al-ijarah structure for the Netherlands will be justified in paragraph three. 11 However, the main focus of this research will be on sukuk and its position in relation to conventional bonds. Therefore, the development of the securitization market within the Islamic finance market and the comparison of securitization with the sukuk al-ijarah structure will not be discussed in this research. 12 This means that regulatory and tax law aspects of sukuk will not be discussed in this research. However, the UK made several legislative changes in order to make the issuance of sukuk possible. These legislative changes regarded tax law and regulatory law. For a better understanding of the regulatory and tax law aspects of sukuk one can examine the reports on these legislative changes: Budget 2007; Budget 2008; HM Revenue & Customs 2008; HM Revenue & Customs 2009; HM Treasury 2007; HM Treasury 2008a; HM Treasury 2008b; HM Treasury & FSA 2008.

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First of all, paragraph two describes the basics of Islamic finance. Since the topic is quite unfamiliar, a general introduction to Islamic finance seems necessary. Besides this, it is also needed in order to understand the several transaction forms, which are used with sukuk. Afterwards, paragraph three discusses sukuk al-ijarah; the essential features of this product, its structure, and a comparison with conventional bonds. In paragraph four this transaction will be structured in order to fit in the Dutch legal system. When structuring the sukuk alijarah some legal questions rise under Dutch civil law and therefore the possibilities and difficulties under Dutch civil law need to be examined. Lastly, a conclusion will be given.

2. INTRODUCTION TO ISLAMIC FINANCE

2.1 Islamic Law The Islamic view of life exists of Aqidah, Akhlaq and the Sharia. The Sharia has given rise to two bodies of Islamic law: Ibadat 13 and Muamalat 14 . Political, economic and social activities are part of Muamalat. So banking and financial activities obviously form part of the economic activities within the Fiqh al-Muamalat. Fiqh is knowledge of the practical regulations and rules of the Sharia acquired by reference to and detailed study of the sources.15 Therefore, it is important to understand what the sources of Islamic law are. Annex A contains a schematic overview of the Islamic view of life.

2.1.1 Sources of Islamic law In accordance with the classical formulation of the sources of Islam there are two classical sources of law. The first one is the Holy Book of the religion Islam, the Quran, which was revealed to the Prophet Muhammad. Some eighty verses of the Quran refer to legal topics, although there are gaps and doubts in these verses as to whether the legal injunction is obligatory or permissive. 16 After the Quran, the second of the classical sources is the collection of authentic Hadith, which is considered to be the proof of the Sunna. The Sunna is the normative or model behaviour of the Prophet. Furthermore, the Sunna was notably continued by the Prophet Muhammads successors, the four Caliphs. The Caliphs, Abu Bakr, Umar, Uthman and Ali, continued to solve the cases which came before them in an ad hoc
13 14

For more on Ibadat see: Nasr 1999, p. 52-56; Kamali 1991, p. 211; Nyazee 1994, p. 67 For more on Muamalat see: Zahrah 1950, p. 57-59; Zaydan 1967, p. 57-58; Al-Misri 1994, p. 52-56 15 Nasr 2002, p. 123 16 Hengst (Recht van de Islam 3) 1985, p. 10; Pearl 1979, p. 1

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manner, and the solutions were based on interpretations of the Quran from where they drew their source.17 The discipline of Usul al-Fiqh, the roots of Islamic law, can be described as the Islamic legal theory. There are four official bases of Islamic law: the Quran, the Sunna, ijma, and qiyas. This illustrates that there are two material sources, a method, and a declaratory authority; the decisive instance is the ijma, since it guarantees the authenticity of the two material sources and it determines their correct interpretation.18 One should keep in mind the vital distinction between the classical sources of Islamic law and the material sources of the law.

2.1.2 Subsidiary sources of Islamic law The use of human reasoning, called ray, played an important part in the development of Islamic law. Ray, however, has the restriction that it can only be applied to Muamalat, because guidelines pertaining to Ibadat are understood by jurists to be beyond reasoning whereas the guidelines pertaining to Muamalat are subject to reasoning. 19 The first specialists and the Qadis started ray with the exercise of personal opinion and individual judgements. Later on, based on individual reasoning, the existence of a number of subsidiary sources of law was conceded: ijtihad, istihsan and istislah. Istihsan and istislah are examples of particular forms of ijtihad. However, these forms were unacceptable and quickly terminated, since they permitted the use of discretion and personal reasoning, even within certain ascertainable limits. 20 Ijtihad was not strictly a source of law, but it was rather a method by which the Mujtahid recognised and made known the legal meaning of the Quranic rules or the Sunna. Once he did this, the consensus of opinion would either reject or accept the theory, and if it was accepted by ijma, it became an incorporated part of the Sharia. From about 900 AD, the exercise of ijtihad had exhausted itself and the door of independent reasoning was closed.21 The position which is taken from then on is taqlid and a person who is bound to practice this is called the muqallid. Under the definitive formulated rule of taqlid, the doctrine must not be independently accrued from the Quran, the Sunna, and ijma, but it must be accepted as it is being taught by one of the recognized schools, which are themselves embraced by consensus.22 There are two main divisions in Islam, Sunni and Shia.23 The
17 18

Pearl 1979, p. 5; For examples see: Coulson 1994, p. 24-5 Schacht 1964, p. 112-115 19 Zaydan 1967, p. 57-58 20 Pearl 1979, p. 15-16 21 Some historians, however, refer to the early tenth century as the date of the closing of the door of ijtihad. See: Pearl 1979, p. 14-15 22 Schacht 1964, p. 71

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four Sunni Islamic schools of law are Hanafi, Maliki, Shafii and Hanbali. 24 And the three Shia branches are Ithna Ashari, Ismaili, and Zaydi.25

An introduction to Islamic law was necessary, in order to understand Islamic finance. Since banking and finance are parts of the economic system, it is also worthwhile to discuss the structure of Islamic economics, under which the Islamic financial system is supposed to work.26

2.2 Islamic Economics

2.2.1 The beginning of Islamic economics One manifestation of the Islamic revival of the late nineteenth century was the emergence of Islamic economics as a distinct branch of economics.27 Sayyid Jamal al-Din al-Afghani was the most influential pioneer of Islamic modernism and anti-imperialism from the 1880s and he sought to change Islam from a religious faith into a politico-religious ideology.28 Much of the effort of the Islamic modernisers was in legal reform and ijtihad.29 The pioneering efforts of al-Afghani were viewed with much respect by the self designated Islamic economists who undertook the re-evaluation of economic theories from an Islamic perspective, since they saw themselves as modernisers in his mould.30 In the early decades of the twentieth century, there were dispersed writings on economic issues throughout the Muslim world. 31 The first influential writer was Sayyid Abu al-Ala Mawdudi, who popularised the term Islamic economics. Many of his followers had a good knowledge of Western neo-classical economics through their undergraduate and postgraduate degrees and professional training, and were later to become significant contributors to the literature themselves.32

23

Islam consists of a number of religious denominations, with the primary division being between Sunni, by far the largest group in Islam, and Shia, the second-largest group in Islam. An important point on which they differ is the question who the rightful successor of the Prophet Muhammad was. 24 Hengst (Recht van de Islam 3) 1985, p. 11; Pearl 1979, p. 16 25 Pearl 1979, p. 17 26 Ayub 2008, p. 41 27 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 195 28 Keddie (Pioneers of the Islamic Revival) 1994, p. 11-29 29 Esposito 1998, p. 126-132 30 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 195 31 Rahman 1942; Ahmad 1947 32 Amongst its most notable contributors this new generation included: Mannan 1970; Siddiqi 1981; Chapra 1992; Naqvi 1994

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2.2.2 Islamic economics, Marxism, and Capitalism Baqir al-Sadr, another writer who was trained in Islamic jurisprudence, wrote Iqtisaduna33 to demonstrate the incompatibility of both Marxism and Capitalism with Islam.34 He rejected the class categorisation of Marxism as simplistic, as capitalists and workers are not just products of a system of production, but are also human beings with moral responsibilities. 35 While material consumption and having power over resources, seen as factors motivating men, are the ends for Marxists, for Muslims these are only the means, while the ends are spiritual.36 Muhammad Nejatullah Siddiqi suggested that Communism is in conflict with the basic requirements of the moral and spiritual growth of the human personality, which in the economic sphere requires private property and freedom of enterprise.37 Since the recognition of private property and the legitimacy of markets are inherent to both, it might appear that Islam has more in common with Capitalism, but Muslim writers see a lack of balance and moderation in Capitalism.38 Mawdudi described Capitalism as extreme, with excessive accent on the rights of individual ownership and freedom of enterprise that inflicted suffering and privation for those who owned little.39 Undue emphasis on self-interest and the profit motive gave rise to a society lacking human character, brotherhood, sympathy and co-operation.40 Islam stresses a more generous attitude with respect to the ownership of wealth, whereas Capitalism is more possessive.41 Syed Nawab Naqvi was critical of the Capitalists neglect of human relations and especially their exploitation of labour.42

2.2.3 Islamic economics as a doctrine Amongst most of the writers there was an apparent disquiet about following positivist economics. 43 Out of these writings some general features come into sight to distinguish Islamic economics as a doctrine. 44 The definition of Islamic economics begins with the assertion of the sources from which the principles and the particulars of the doctrine are to be derived: the Quran, the Sunna, ijma, and qiyas. Just like in the other fields of Islamic
33 34

Al-Sadr 1961; Shubber 2000; Rieck 1984 Wilson 1998, p. 46-59 35 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 202 36 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 202 37 Siddiqi 1981, p. 52-53 38 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 203 39 Mawdudi 1966, p. 52-83 40 Siddiqi 1981, p. 46 41 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 205 42 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 205 43 Al-Bali 1987, p. 31-3; Nur 1978, p. 18-20; Kamal 1980, p. 17-18; Al-Fanjari 1981, p. 18-20; Al-Fanjari 1986, p. 91-3; Uthman 1990, p. 33-4 44 Tripp 2006, p. 111

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knowledge and prescription, various writers differ about the degree of latitude allowed to reasoned interpretation through ijtihad, as well as about the selection of jurists to be cited as authoritative sources for understanding the rules of Islamic economy.45 As a consequence of this, there were contrasting approaches among Muslim intellectuals helping to define this field.46 Some of these intellectuals focused on the explication of Quranic verses and on the writings of the jurists over the centuries, presenting expository account of what these sources have to say about riba, zakat, ushr and kharaj, the status of property, accounting and the market.47 Whereas others have addressed current economic affairs of a generic nature, seeking to brew prescriptions for economic activity with an explicit set of Islamic values, and endeavouring to ensure that their exhortations remain true to the principles contained in the founding texts, while trying to engage successfully with the economic sphere as presently constituted at the same time.48 However, all the above leads to some distinguishing features of Islamic economics: (1) the principles of Islamic economics derive from Islamic sources; (2) conform Islamic economics, human beings should be driven by moral, ethical, and spiritual motives; (3) Islamic economics recognizes private property; (4) freedom of enterprise and legitimacy of markets is inherent to Islamic economics; and (5) in accordance to Islamic economics, human well-being should be realised through an allocation and distribution of scarce resources to achieve economic equality and emphasise fairness in society.

Although Mawdudi had coined the term Islamic economics, it was merely from the 1970s that the subject took on some of the characteristics of an academic discipline, and by then it had its own group of scholars engaged in academic debate and a growing literature of books and journal articles. 49 At the institutional level this was helped by the newly formed Organisation of the Islamic Conference.50 The work of most of the writers was brought to the attention of a wider community of Muslim scholars when Muhammad Nejatullah Siddiqi published his survey of contemporary literature on Islamic economics for the First International Conference on Islamic Economics held in Mecca in 1976 under the auspices of King Abdulaziz University of Jeddah.51

45 46

Nur 1978, p. 53-5 Tripp 2006, p. 111-112 47 Philip 1990, p. 124-8; Nomani & Rahnema 1994, p. 45-8. For traditional approaches to the identification of Islamic economics see: Yahia 1988; Al-Abbadi 1977; Al-Masri 1989; Imam 1986; Al-Qardawi 1995. 48 Tripp 2006, p. 111-112 49 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 200 50 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 200 51 Siddiqi 1981

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2.3 Islamic Finance

Islamic banking and monetary theory is arguably the most developed area of Islamic economics, where real progress has been achieved in terms of implementation, both within and outside the Muslim world.52 From the 1950s, publications on interest-free banking started to appear and a notable early contributor was the scholar Muhammad Uzair. 53 The key concept is that lenders must participate in the risk of the business, in order to earn a reward.54 The Islamic economic model emphasises fairness, which is reflected in the requirement that everyone involved in a transaction makes informed decisions and is not misled.55 Basically, Islamic banking has the same purpose as conventional banking, except that it operates in accordance with the Fiqh al-Muamalat, which contains the Islamic rules on transaction.56 2.3.1 Sharia review board Most Islamic banks appoint a board or committee of religious scholars who are tasked with reviewing the banks Islamic operations and transactions in order to ensure that they comply with the Fiqh al Muamalat. 57 This Sharia review board gives an approval report, also known as a fatwa, to the bank. The fatwa contains the argumentation of the review board and describes the Sharia rules underlying the contract form. 58 The Sharia review board also assesses whether business is conducted in a Sharia-compliant manner59 and it plays a role that is comparable with the Supervisory Board at a conventional financial institution.60 Most Sharia review boards consist of an uneven number of scholars, with the minimum of three, to avoid stalemates in the case of conflicting opinions, since they decide by majority vote.61 The Sharia review board can base its judgements on diverse Islamic schools of thought, so it is possible that a fatwa of one review board is based on the interpretation that is not endorsed by other Sharia review boards and, consequently, a product can be considered Shariacompliant by one review board and non-compliant by another.62 Therefore, consensus on this

52 53

Wilson (Islamic Thought in the Twentieth Century) 2004, p. 210 Uzair 1955 54 Zaman 2008, p. 41 55 Ainley et al. 2007, p. 4 56 Qadri 2008, p. 59 57 Hanif 2008, p. 10 58 Thomas, Cox & Kraty 2005, p. 32-35 59 This concerns e.g. the product development process, the financing method, the sales process, and the administrative handling. 60 Verhoef, Azahaf & Bijkerk 2008, p. 13 61 Verhoef, Azahaf & Bijkerk 2008, p. 12 62 Verhoef, Azahaf & Bijkerk 2008, p. 12

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part is needed. This is were forums like the Accounting and Auditing Organization for Islamic Financial Institutions63 (AAOIFI), which publishes the widely followed Sharia Standards, and the Islamic Financial Services Board 64 (IFSB), which publishes various technical standards for Islamic banks, play an important role.65

2.3.2 Islamic principles in general

2.3.2.1 The concept of making profit Although one would think the opposite, making profit by trade is stimulated by Islam. 66 Islam encourages and promotes the right of individuals to pursue personal economic wellbeing.67 Striving to gain profit is ethically justified, as long as higher values stay intact.68 Islam even stimulates commercial transactions.69 Trade should take place based upon a legal structure: there should be a contract.70 A contract is binding and has to be executed.71 The legal concept of good faith should be known in the contract. 72 This means that the seller has a precontractual obligation to inform the purchaser about the quality of the goods.73 The Quran encourages the written commitment of a commercial contract. 74 So generally in Islam, commercial transactions and contracts are permissible, unless there is a clear prohibition or unless it is haram, i.e. forbidden by Islamic law.75

2.3.2.2 Halal transactions In general, Muslims are not allowed to engage in activities which are prohibited under the Sharia. For a transaction, this means that all activities should be for permitted purposes, so they should be halal transactions. It is not permissible to invest in businesses which are haram. These prohibited investments concern investments relating to, amongst others, alcohol, pork, armaments, military technology, pornography, prostitution, and gambling. 76 It also not
63 64

AAOIFI Overview, http://www.aaoifi.com/overview.html (last visited September 20, 2009) Islamic Financial Services Board, http://www.ifsb.org/ (last visited September 20, 2009) 65 Holden 2007, p. 362 66 Quran 2:275 67 Ainley et al. 2007, p. 4 68 Kung 2006, p. 742 69 Quran 4:29; Quran 2:275 70 Tjittes 2008, p. 139 71 Quran 5:1; Quran 17:34 72 Quran 17:35; Majeed 2004, p. 97 et seq. 73 Tjittes 2008, p. 139 74 Quran 2:282 75 Kamali 2000, p. 45 76 Vine et al. 2008, p. 414-415

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permissible to provide any financing to conventional businesses, which are not Shariacompliant. A very strict rule, however, would have the consequence that Islamic banks would not be able to invest in a large number of businesses. Therefore, in light of the practical considerations of international commerce and to enable Islamic banks to participate in it, a number of prominent Sharia scholars have advanced the view that it is permissible to invest in businesses which are not entirely Sharia-compliant so long as certain conditions are met: (1) the principal business activity must be permissible under the Sharia; (2) any income derived from prohibit activities should only form a small percentage77 of the overall income of the company; (3) the aggregate amount of interest that a company is obliged to pay under loans taken out by it, must not exceed a certain percentage78 of its assets.79

2.3.2.3 Zakat One of the five pillars of Islam, the five duties incumbent on every Muslim, is zakat, giving alms.80 It derives from the Quran81 that the payment of zakat, a tax on property, results in purification from sin.82 The notion is that if an owner sees the value of his property increase, then he should share some of this growing prosperity in this world to gain favour in the next.83 It is a mandatory charity that, beyond a threshold of one years accumulated wealth, every Muslim has to pay to the poor and the needy.84

2.3.3 Prohibitions in Islamic finance

2.3.3.1 Riba The most important rule of Islamic finance is the prohibition of paying and receiving riba, which is often, although inaccurately, translated as interest.85 There are many Quranic verses prohibiting riba.86 Given the breadth of the doctrine of riba, it is also translated as unjustified
77

This percentage ranges from 5 to 20 per cent of the overall income depending upon the nature of the prohibited activity concerned and the Sharia scholars involved. 78 There are disagreements between Sharia scholars as to what percentage is acceptable, but it ranges from 25 to 40 per cent of total assets depending upon the scholars involved. 79 Hanif 2008, p. 10 80 The other four pillars of Islam are: Shahada, profession of faith; Salat, prayers; Sawm, fasting during the holy month of Ramadan; Hajj, pilgrimage to Mecca. 81 Quran 87:14 82 Aghnides 1961, p. 208 83 Wilson (Islamic Thought in the Twentieth Century) 2004, p. 214 84 Durrani & Boocock 2006, p. 152 85 El-Gamal 2006, p. 11-12 86 Quran 2:275; Quran 2:276; Quran 2:277; Quran 2:278; Quran 2:279; Quran 2:280; Quran 2:281; Quran 3:130; Quran 4:161; Quran 30:39

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enrichment.87 Ibn Rushd, also known as Averroes, stated that the jurists agreed that usury88 is found in two things: (1) sales and (2) that which is established as a liability through sale, credit, or other transactions.89 Riba which is incurred as a liability is of two kinds.90 First is that about which there is no agreement and this is the riba of the period of jahiliyya91.92 The second kind is loss for hastening (the period).93 Riba in sales is also of two kinds: delayed (nasia) and stipulated excess (tafadul).94 So the two kinds of riba in sales are called riba alfadl and riba al-nasia. Riba al-fadl concerns all sales within a single type with inequality, with or without delay.95 While riba al-nasia concerns all exchanges with delay among the listed goods, with or without equality or identity of type.96 Figure 2.197 Ibn Rushd on riba

Riba

Sales

Liability through sale, credit, or other transactions

Riba al-fadl

Riba al-nasia

Riba of the period of jahiliyya

Loss for hastening (the period)

87 88

Vogel & Hayes 1998, p. 84 In this context the word usury is used in the obsolete sense, meaning: interest paid for the use of money, since it concerns one of the works of Ibn Rushd (1126 1198). For the rest of the study the word usury will indicate: the lending or practice of lending money at an exorbitant amount or rate of interest, especially in excess of the legal rate. See: http://www.dictionary.com (last visited September 20, 2009) 89 Ibn Rushd 1994, p. 158 90 Ibn Rushd 1994, p. 158 91 The period of jahiliyya is the pre-Islamic age and this form of riba is prohibited, as they used to stipulate excess in loans and then delay the period (of repayment). 92 Ibn Rushd 1994, p. 158 93 This form is called the da wa taajjal. It can be seen as a discount granted for early repayment outstanding debt, before the expiry of the stipulated period. See: Ibn Rushd 1994, p. 158 94 Ibn Rushd 1994, p. 158 95 Vogel & Hayes 1998, p. 74 96 Vogel & Hayes 1998, p. 74 97 Authors own

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Interest on loans is the forbidden riba al-nasia.98 The term interest here is general and leads to the claim that Islam does not accept the notion of a time value of money. 99 There is much discussion whether the term riba, which is derived from the Arabic root meaning to grow or to be in excess, covers all forms of interest or refers only to exorbitant usury. 100 Those who suggest that it refers to the latter, base it on the belief that the true spirit of the ban on riba is the goal of preventing exploitation of the weak.101 Indeed, one of the purposes being served by this prohibition is the potential for rich creditors exploiting poor debtors, but this is not the only purpose of the prohibition of riba. Furthermore, riba is also prohibited to avoid injustice.102 Injustice here is a symmetric relation, which depends only on the lent sum and not on the relative wealth of the parties, or their respective positions as creditor and debtor.103 Therefore, it is stated that all forms of interest is forbidden. Jurists have almost unanimously forbidden commercial bank interest. 104 One reason advanced for this, is that the Sharia countenances lending money as a charitable activity and not necessarily a profit making venture.105 For modern Muslims jurists who believe that lending at interest is unlawful, the doctrine of riba is viewed as a mean to achieve economic justice.106 Furthermore, money must be used to create real economic value and it is only permissible to earn a return from investing money in a permissible commercial activity which involves the financier or investor taking some commercial risk.107 Riba is not a payment for taking risks, nor is it the reward for a constructive activity.108 The prohibition of it indirectly leads to the prohibition of pure debt security; instead of debt other forms of financing based on the principle of sharing of profit and loss are recommended. So although Islamic banks cannot charge fixed interest in advance, they operate by participating in the profit resulting from the use of bank funds.109 The concept

98 99

El-Gamal 2008, p. 29-58 Al-Sadr 1980; Mawdudi 1979 100 The existence of this discussion relies on the fact that it is not clear where it derives from. Riba comes from the root rab-a meaning to increase (or exceed), while rib.h comes from the root rabi.ha meaning to gain (or profit). For more on this discussion see: Lewis & Algaoud 2001, p. 35; Wilson 1991, p. 14 101 Saeed 1996, p. 41 102 Quran 2:278; Quran 2:279 103 So injustice mentioned here is economical, indicating that there is no valid justification for any given increase or diminution, thus such increase or diminution leads itself to injustice. See for more: El-Gamal 2008, p. 29-58 104 Al-Zuhayli 2003, p. 339-352 105 Moghul & Ahmed 2003, p. 168 106 Fadel 2008, p. 677 107 Hanif 2008, p. 10 108 Olson & Zoubi 2008, p. 47 109 Olson & Zoubi 2008, p. 47

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of interest is replaced by profit and loss sharing, but a mark-up for delayed payments and trade-financing commissions are allowed under the Islamic banking model.110

2.3.3.2 Gharar Another important prohibition concerns the prohibition of gharar 111 in contracts, which means that there should not be uncertainty as to the subject-matter of a contract. A financial contract should not lack specificity in its terms112, i.e. in its sale price, deliverability, quantity, quality, existence, etc. 113 Therefore, open-ended terms and those that are deliberately structured to convey more than one meaning are prohibited. 114 In relation to conventional finance, gharar exists, among others, in insurance, futures and options contracts. 115 As mentioned before, sharing the business risks is an important aspect within Islamic finance, because that creates a balance between the parties and emphasises fairness. Business risks that are generated by financial and commercial factors are allowed as long as the parties to the transaction have advanced knowledge of the elements which constitute the transaction. 116 The rationales for prohibiting gharar include mitigating disputes over the interpretation of contacts and mitigating problems arising from asymmetric information, so that injustice and inequity does not fall on the ill-advised contracting party from the outset. 117 However, a transaction with minimal gharar could be valid, because the Sharia acknowledges the impossibility of totally eradicating gharar. 118 For gharar to invalidate a contract: (1) such gharar must be excessive and not trivial; (2) it must pertain to the subject of the matter of the sale; and (3) society must not be in need of the contract in question.119 The latter explains why forward sale (salam), manufacture (istisna), and leasing (ijarah) contracts have traditionally been permitted under Islamic law, despite the arguable presence of gharar in these contracts.120

110 111

Olson & Zoubi 2008, p. 47 Quran 2:90; Quran 2:91 112 DeLorenzo (Islamic Finance: Innovation and Growth) 2002, p. 22 113 Archer & Karim (Islamic Finance: Innovation and Growth) 2002, p. 3; IOSCO 2004 114 Ahmed (Islamic Finance: Innovation and Growth) 2002, p. 109 115 Jabbar 2009, p. 24 116 Saleh & Ajaj 1992, p. 81 117 Saleh & Ajaj 1992, p. 80-81; Archer & Karim (Islamic Finance: Innovation and Growth) 2002, p. 3 118 Fadeel (Islamic Finance: Innovation and Growth) 2002, p. 91; IOSCO 2004 119 Moghul & Ahmed 2003, p. 171-172 120 Kamali 2000, p. 85; Al-Zuhayli 2003, p. 385

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2.3.3.3 Mayseer and Qimar Mayseer and qimar are also prohibited under the Sharia.121 Mayseer concerns a transaction, where something is gained by purely speculation and not by productive effort. 122 Qimar includes every form of gain of money, the acquisition of which purely depends on luck and chance.123 Speculation or gambling exists whereby two or more parties each undertake the risk of a loss where a loss for one means the gain for the other. 124 This is prohibited, because it involves an attempt to make profit and amass wealth without putting in any productive effort.125 Conventional future contracts and equity derivatives have the element of mayseer.126 However, general commercial speculation in genuine commercial transactions, which take place in a situation whereby a financier makes an investment in a Sharia-compliant business and speculates for a return for the investment, is not prohibited under the Sharia.

2.3.4 Islamic financial contracts and structures Islamic financial contracts can be subdivided into two categories: (1) transaction contracts, which concern transactions in commodities and the financing of economic activities, and (2) intermediation contracts, which promote the efficient and transparent execution of the transaction contracts.127 For a schematic overview of these contracts and the Islamic financial structures see Annex B. The four most common Islamic financial structures will be discussed below.

2.3.4.1 Murabaha Murabaha contracts are contracts which include a mark-up, i.e. a profit margin is added to the purchase price in order to make profit, so there is a difference between the purchase price of the asset and its selling price. In Islamic financial transactions these contracts are used as an alternative for loans. In the murabaha contract, the buyer knows the purchase price and agrees to pay a profit margin to the bank. 128 The bank is not compensated for the time value of money outside of the contracted profit margin.129 This concept is widely utilized in Islamic mortgage transactions: instead of loaning the money to the buyer to purchase property, the
121 122

Quran 2:219; Quran 5:90 Hanif 2008, p. 10 123 Ayub 2008, p. 112 124 IOSCO 2004 125 IOSCO 2004 126 Hanif 2008, p. 10; Jabbar 2009, p. 25 127 Verhoef, Azahaf & Bijkerk 2008, p. 13 128 El-Gamal 2000, p. 10-11 129 Qadri 2008, p. 60

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bank might buy the property itself from the seller, and then re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in instalments.130 There are no additional penalties for late payment, and therefore, the bank requires strict collateral. 131 Notice that in this contract, the bank must own the item at the time the customer buys it from them with the specified profit margin.132 Afterwards, the good or land is registered in the name of the buyer, and accordingly, the buyer is in fact able to benefit and receive tax credits.133 The concept of cost plus sales in murabaha is not considered as interest and, therefore, justified from an Islamic perspective, because (1) the financier shares in the risk, such as theft or damage to the property, since it owns the property for a short time; (2) the financier acts as an agent in the trades sale; and (3) the object of the trade sale is not money, but a property.134

2.3.4.2 Mudarabah and musharaka Mudarabah and musharaka are forms of partnership. Financing through mudarabah, which can be viewed as venture capital, and musharaka, which is commonly referred to as joint venture, means participation in the business by the financier. 135 Profits, determined as a proportion or percentage, will be distributed among the partners on the basis of the proportion settled by them in advance.136 The profit sharing continues until the entrepreneur becomes the complete owner of the business, which often takes the form of a buy-out of the interest of the financing entity.137 In a mudarabah contract the financing entity, which is called rab-al-maal, provides the funding for the business venture; and the entrepreneur, the so called mudarib, provides expertise, labor, and management.138 While the financial investment by each party may be unequal in a musharaka contract, each partner retains an equal right to management and participation in the business. 139 Another important difference between the mudarabah contract and the musharaka contract concerns the fact that in a mudarabah contract the rabal-maal bears all the losses, because the mudarib does not invest anything. One should not
130 131

Qadri 2008, p. 60 Qadri 2008, p. 60 132 El-Gamal 2000, p. 10-11 133 Tax credit refers to (1) a recognition of partial payment already made towards taxes due; or (2) to a state benefit paid to workers through the tax system. Both concepts are not known in the Netherlands, so it is not relevant for the Dutch legal context. However, the fact that the asset is registered in the name of the buyer is also important in the Netherlands, because this is relevant for the deductibility of the profit mark-up as a cost of home financing the so called eigenwoningschuld - due to the Income Tax Act 2001 (Wet Inkomstenbelasting 2001). For more on this see: Muller & Hooft 2008a. 134 El Idrissi 2008, p. 41 135 Usmani 2002, p. 17 136 Qadri 2008, p. 59-60 137 Qadri 2008, p. 59-60 138 Qadri 2008, p. 59-60 139 Qadri 2008, p. 59-60

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overlook the fact that the mudarib sustains the loss of the time and the effort he has put in the venture.140 Furthermore, the mudarib shall be liable for the loss caused by his negligence or misconduct, if he has worked with negligence or has committed dishonesty. 141 Meanwhile, in a musharaka contract each financier must share the loss incurred by the business to the extent of his financing. 142 This concept reflects the Islamic view that there should be a balance between the parties: the borrower must not bear all the risks of a failure, and the lender must not receive all the profits.143 2.3.4.3 Salam and istisna These contracts are Islamic forward contracts. The sale of non-existent objects is forbidden, because of the prohibition on gharar. However, there are two contracts which form an exception: salam and istisna. In a salam contract, a buyer pays immediately for a commodity or other fungible good, which the seller will deliver at a specified future date. 144 An istisna contract involves the forward purchase of a good to be manufactured to certain specifications.145 The price is paid in instalments as the work progresses in manufacturing the otherwise non-existent object.146

2.3.4.4 Ijarah and ijarah-wa-iqtina Ijarah and ijarah-wa-iqtina contracts are comparable to leasing contracts. Legally, a lease contract is not the sale of the object, but rather the sale of the usufruct147 for a specified period of time.148 The sale of usufruct is permissible in Islam.149 The leasing agency must own the leased object for the duration of the lease in an ijarah contract.150 Under an ijarah contract, the bank makes available to the customer the use of an asset for a fixed period against agreed upon rental.151 The corpus of the leased property remains the ownership of the lessor, and only its usufruct is transferred to the lessee. 152 Thus, all the liabilities emerging from the ownership shall be borne by the lessor, but the liabilities referable to the use of the property
140 141

De Vries Robbe & Ali 2005, p. 365 Usmani 2002, p. 13 142 Usmani 2002, p. 17 143 Qadri 2008, p. 59-60 144 Vogel & Hayes 1998, p. 220 145 Vogel & Hayes 1998, p. 220 146 El-Gamal 2000, p. 17 147 The word usufruct here indicates the right to use an object. 148 El-Gamal 2000, p. 13-14 149 Quran 28:26; Quran 28:27; Quran 65:6 150 El-Gamal 2000, p. 13-14 151 Ayub 2008, p. 280 152 Usmani 2002, p. 70-71

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shall be borne by the lessee.153 Another well-known contract is the ijarah-wa-iqtina, under which a bank provides assets to the client under an agreed rental, together with a unilateral undertaking by the bank or the client where at the end of the lease period, the ownership in the asset would be transferred to the lessee.154

3. SUKUK

3.1 Introduction to Sukuk In the light of the prohibition of riba under the Sharia, pure debt instruments are forbidden in Islam and, therefore, sukuk are structured to generate the same economic effects as conventional bonds, but in a Sharia-compliant manner.155 The word sukuk is the plural of sakk and the latter represents an undivided interest in an asset.156 Sukuk reflect participation in the underlying tangible assets, so that what is being traded is not mere a debt. 157 This term is recognized in traditional Islamic jurisprudence.158 Sukuk are entitlement to rights in certain assets inclusive of some degree of ownership.159 For sukuk structure to comply with Sharia, the underlying assets must themselves also comply with Sharia, which means that they should be halal. 160 The structures of different sukuk are based on the Islamic financial contracts, as outlined in the previous paragraph. Both government- and corporate sukuk can be issued. The following paragraph will discuss sukuk structures to illustrate how sukuk works. Since these instruments are often compared to bonds, in the last paragraph of this paragraph sukuk will be compared to bonds.

3.2 Sukuk Structures The AAOIFI recognizes fourteen different types of sukuk.161 Since there are fourteen possible structures, it is not possible to find one overarching legal solution for all types of sukuk and,

153 154

Usmani 2002, p. 70-71 Qadri 2008, p. 60-61 155 Ainley et al. 2007, p. 24 156 Adam & Thomas 2004, p. 42 157 Iqbal & Mirakhor 2006, p. 177; Saqqaf 2006, p. 19 158 More on this see: Adam & Thomas 2004, p. 42-48 159 Allen & Overy 2003 160 Box & Asaria 2005, p. 22; McMillen 2006, p. 427-429 161 The fourteen sukuk structures are: sukuk al-ijarah, sukuk ijarah-mowsufa-bithima, sukuk manfaa-ijarah, sukuk manfaa-ijarah-mowsufa-bithima, sukuk milkiyat-al-khadamt, sukuk al-salam, sukuk al-istisna, sukuk al-

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therefore, these instruments need to be examined on a case-by-case basis. 162 Most of the structures are Sharia-compatible for trading in the secondary market163, except the salam, istisna and murabaha sukuk. 164 These forms of sukuk cannot be traded in the secondary market, because these contracts create debt as a result of the salam-, istisna-, and murabahabased sale.165 It will be too long-winded and outside the scope of this research to describe the complete structure of these three forms, but for the point made it is important to know that in these structures there is no (degree of ownership in the) underlying asset and, therefore, the payments are not cash flows from an asset or a business, but they are merely debts. Since it is not allowed to trade in debts due to the prohibition on riba, these forms of sukuk cannot be traded in the secondary market. Otherwise, that would lead to dealing with riba while trading in securities and riba is prohibited by the Sharia. On that account, merely sukuk al-ijarah will be described in this paragraph. The UK preferred, and therefore examined, this structure to form the basis of a government sovereign sukuk issue. 166 Furthermore, most of the corporate sukuk issues in the UK are structured through the sukuk al-ijarah structure. Sukuk structures are based on English concepts. Typically, the vast majority of internationally traded contracts are drafted so that English law applies. 167 English law dominates the world of international finance 168 and, consequently, English structures are also used in sukuk transactions. The UK plays a major role in the Islamic finance market as well, thus English concepts are used for the legal structures of sukuk, as will be outlined below.

3.2.1 Sukuk al-ijarah This structure is based on the ijarah contract.169 As mentioned in the previous paragraph, an ijarah contract allows the transfer of usufruct of an asset in return for rental payment; as such it is similar to a conventional lease contract.170 Basically, under the sukuk al-ijarah structure the Special Purpose Vehicle (SPV) holds the assets in trust for the sukuk holders. Figure 3.1
murabaha, sukuk al-musharaka, sukuk al-mudarabah, sukuk al-wakala, sukuk al-muzraa, sukuk al-musaqa, sukuk al-muqarasa. For more on these structures see: Lahlou & Tanega 2007, p. 367-368 162 Ainley et al. 2007, p. 25 163 The secondary market is the financial market where previously issued securities and financial instruments, such as stocks, bonds, shares, and also sukuk, are bought and sold. See: http://www.businessdictionary.com/ (last visited September 20, 2009) 164 Some particular cases of muzaraah and musaqah sukuk also are not Sharia-compatible for trading in the secondary market, when the sukuk holder does not own the land. For more see: Iqbal & Mirakhor 2006, p. 181 165 Iqbal & Mirakhor 2006, p. 181 166 HM Treasury 2007, p. 17-19 167 Islamic Finance Resources 2009 168 Wood 2008, p. 15-28 169 Iqbal & Mirakhor 2006, p. 182 170 HM Revenue & Customs 2008, p. 20; HM Treasury 2007, p. 17

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illustrates the structure of sukuk al-ijarah. In this structure the SPV purchases certain assets from the originator, as the seller of these assets, at an agreed predetermined purchase price. In order to finance the purchase, the SPV issues sukuk to sukuk holders, who are the investors. These sukuk are based on the underlying assets that the SPV has acquired rather than being debt securities, which is the case with the issuance of conventional bonds.171 The SPV uses the sukuk proceeds to pay the originator. Afterwards, a lease agreement between the originator and the SPV is signed for a fixed period of time. Under this lease agreement the originator leases back the assets as lessee. Consequently, the SPV receives periodic rentals from the originator as lessee. And the SPV uses these amounts to pay the periodic return to the sukuk holders, who will have a certain degree of ownership in the underlying asset. At maturity, the originator purchases back the assets from the SPV at a predetermined value. The originator gets back the beneficial title to the assets. And the SPV can pay the sukuk holders their capital back, which allows the sukuk certificates to be redeemed. So sukuk al-ijarah uses this leasing contract as the basis for the returns paid to investors, who are the beneficial owners of the underlying asset and as such benefit from the lease rentals as well as sharing in the risk.172 Figure 3.1173 Structure of sukuk al-ijarah

Transfer of assets & sukuk proceeds

Sukuk issuance & sukuk proceeds

Originator
Lease back & periodic rentals

SPV
Periodic payments

Sukuk holders

The sukuk al-ijarah is the most important structure. The AAOIFI stated that sukuk al-ijarah is the most Sharia-compliant form of sukuk. 174 As mentioned before, AAOIFI standards are widely followed across many countries, so this statement is very valuable. Furthermore, Moodys reported that sukuk al-ijarah was the dominant sukuk structure in terms of issuance

171 172

HM Revenue & Customs 2008, p. 20; HM Treasury 2007, p. 17 HM Revenue & Customs 2008, p. 20; HM Treasury 2007, p. 17 173 Authors own 174 AAOIFI Shariah Board 2008

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volume in 2008, replacing mudarabah which was the dominant structure in 2007.175 Most of the corporate sukuk in the UK has been structured through the sukuk al-ijarah, since it was suggested that it is the most suitable model to be adopted in the UK. This shows the importance of the sukuk al-ijarah and justifies the choice for it to be structured in the Netherlands, which will happen in the next paragraph.

3.3 Sukuk and Conventional Bonds

3.3.1 Similarities between sukuk and conventional bonds When comparing sukuk with conventional bonds, one will find some generic features. First of all, virtually all sukuk issued today, like bonds, guarantee the return of the principal when redeemed at maturity, regardless whether the enterprise was profitable.
176

This is

accomplished by means of a binding promise from either the issuer or the manager to repurchase the assets represented by the sukuk at the stated price at which these were originally purchased by the sukuk holders at the beginning of the process, regardless of their true market value at maturity.177 This practice is only lawful if the resale takes place on the basis of the net value 178 of the assets or at a price that is agreed upon at the time of purchase.179

Moreover, sukuk are, like conventional bonds, versatile. The variety of sukuk structures that are defined in the AAOIFI standards: (1) allow for structuring across legal and tax domains of products that meet diverse financing needs; (2) may offer fixed and variable income options; (3) may achieve cross-listing capabilities; and (4) are compatible with global bond regulations.180 The AAOIFI recognizes fourteen different types of sukuk and that illustrates the versatility of sukuk as well.

3.3.2 Differences between sukuk and conventional bonds There are three main differences between sukuk and conventional bonds. First of all, a bond is a contractual debt obligation whereby the issuer is contractually obliged to pay the

175 176

Moodys Global Credit Research 2009 Usmani 2008, p. 4 177 Usmani 2008, p. 4 178 So unlike conventional bonds, the repurchase of assets at face value is not allowed and is considered unlawful. 179 Usmani 2008, p. 14 180 Dar Al Istithmar 2006, p. 7; Adam & Thomas 2004, p. 53

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bondholders interest and principal.181 This differs from sukuk, since sukuk holders each hold a beneficial ownership in the underlying assets.182 Bonds do not represent ownership on the part of the bond holders in the commercial or industrial enterprises for which the bonds were issued.183 Consequently, sukuk holders are entitled to share in the revenues generated by the sukuk assets as well as being entitled to share in the proceeds of the realization of the sukuk assets. 184 However, the market has witnessed a number of sukuk in which there is doubt regarding their representation of ownership recently, e.g. the assets in sukuk may be shares of companies that do not confer true ownership but which merely offer sukuk holders a right to returns.185

Another difference concerns the fact that in sukuk structures, financial instruments, including debts, may not be assigned to other persons unless there are underlying tangible assets. Therefore, a SPV needs to hold the underlying tangible assets in order to issue sukuk.186 So sukuk are financial instruments that are backed by certain specific assets, while bonds are backed by all assets of a company.187 This means that bonds can also be issued by an issuer who merely owns debt. This is not possible for sukuk, because there must always be underlying tangible assets which will be transferred to a SPV, who will hold them in trust for the sukuk holders. Initially, these instruments were viewed as asset-backed debt instruments, but some practitioners think sukuk are asset-based rather than asset-backed.188

Lastly, while bonds create a lender-borrower relationship, the relationship in sukuk depends on the nature of the contract underlying the sukuk, e.g. the ijarah contract creates a lesseelessor relationship.189

181 182

Dar Al Istithmar 2006, p. 7; Cakir & Raei 2007, p. 4 Dar Al Istithmar 2006, p. 7; Cakir & Raei 2007, p. 4 183 Usmani, p. 3 184 Dar Al Istithmar 2006, p. 7 185 Such sukuk are no more than the purchase of returns from shares, and this is not lawful from a Sharia perspective. Likewise, there has been a proliferation of certain sukuk that are based on a mix of ijarah, istisna and murabaha contracts undertaken by Islamic banks such that these are packaged and sold to sukuk holders who hope to obtain the returns from these operations. However, the inclusion of murabaha contracts into such sukuk brings into question the issue of sale of debt and, generally speaking, the sale of debt is prohibited under the Sharia. For more see: Usmani 2008, p. 3 186 It is not enough that the entity holds someone to the promise to pay the debt. For more see: Joseph 2007, p. 70 187 Joseph 2007, p. 70 188 Ainley et al. 2007, p. 25 189 Iqbal & Mirakhor 2006, p. 178

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4. SUKUK AL-IJARAH IN THE NETHERLANDS

4.1 Requirements of Sukuk al-Ijarah

This paragraph deals with the legal structure of sukuk in the Netherlands. When structuring sukuk al-ijarah in the Netherlands, one has to bear in mind certain Sharia and transactional requirements. The first paragraph of this paragraph will deal with the requirements which are important for a sukuk al-ijarah transaction from a Sharia perspective. This concerns the prohibition on riba and other principles of Islamic finance which are important for the sukuk al-ijarah. Furthermore, the transactional requirements of a sukuk al-ijarah transaction will be discussed. This includes the valid transfer of the assets to the SPV and the bankruptcy remoteness of the SPV. The second paragraph describes the legal structure of sukuk al-ijarah in the Netherlands. This is important, because it deals with the qualification of sukuk al-ijarah in the Dutch legal context. Issues such as the sale-and-lease-back (SALB) of the tangible assets from the originator to the SPV and the issuance of sukuk by the SPV, whereby the position of the SPV acting as a trustee for the sukuk holders, will be dealt with. 4.1.1 Sharia requirements of sukuk al-ijarah Paragraph one already discussed the most important principles of Islamic finance. The most relevant and important principles for the sukuk al-ijarah structure will be discussed in order to illustrate which requirements the structure must meet under the Sharia. The most important Islamic principle for the sukuk al-ijarah transaction and probably for Islamic finance as a whole is the prohibition of riba. This will be discussed firstly, followed by other important principles.

4.1.1.1 Prohibition on riba The prohibition on riba can be divided into two important aspects for the sukuk al-ijarah transaction. The first concerns the prohibition of interest. This means that interest is forbidden in the whole structure. In the sukuk al-ijarah structure there are two transactions which can contain interest: (1) the lease payments from the originator to the SPV; and (2) the periodic payments from the SPV to the sukuk holders, which is comparable to interest in a regular bond. Both interest payments are forbidden under the Sharia, because of the prohibition on riba. Secondly, the prohibition on riba indirectly leads to the prohibition of pure debt security, as has been discussed in paragraph one and two. Therefore, pure debt instruments are - 23 -

forbidden. Money must be used to create real economic value and the trade in claims and receivables is not allowed. Consequently, debts may not be assigned to other persons and there must be underlying tangible assets in the transaction. This means that the SPV needs to hold underlying tangible assets in order to issue sukuk.

4.1.1.2 Other principles Furthermore, there are three relevant principles that lead to requirements which should be met for a sukuk al-ijarah structure to be Sharia-compliant. The first one concerns the prohibition of gharar, which refers to the prohibition of uncertainties. This means that a transaction cannot be contingent on the occurrence of another transaction because this would lead to uncertainties. This is relevant at the point of the SALB of the assets between the originator and the SPV and the buy-back of the assets by the originator from the SPV at maturity. The next paragraph will discuss this in more detail. Another important requirement is that the underlying tangible assets should be halal and should not be involved in or meant for haram activities. These prohibited activities refer to investments relating to, amongst others, alcohol, pork, armaments and military technology, pornography and prostitution, and gambling. But to a certain extent also any financing to conventional businesses, which are not Shariacompliant. Paragraph one discussed this Islamic principle clearly. The last, and most distinctive, Islamic principle for sukuk al-ijarah under the Sharia concerns the requirement that sukuk holders most hold some degree of ownership in the underlying tangible assets. It is important to stress that sukuk transactions should create a beneficial ownership interest for the sukuk holders in the underlying assets. 190 Therefore, mostly the SPV functions as a trust, whereby the SPV becomes the legal owner of the underlying assets and the sukuk holders become the beneficial owners. The Sharia merely requires some degree of ownership for the sukuk holders in the underlying tangible assets and it is sufficient if the sukuk holders are the beneficial owners of the underlying tangible assets. This can be realised through certification, since certification is an instrument which creates a situation whereby the legal owner holds the assets in favour of the beneficial owner.191 Furthermore, the scope of the charter of the Dutch foundation known as a stichting (foundation) contains the obligation that the SPV must hold the assets in favour of the sukuk holders. 192 Both aspects are creating the beneficial

190 191

Abdel-Khaleq & Richardson 2006, p. 418-419 Van der Grinten & Teurniet 1964, p. 7; Van der Grinten & Teurniet 1964, p. 86-87 192 Uniken Venema & Eisma 1990, p. 335; Reehuis et al. 2006, p. 98; Snijders & Rank-Berenschot 2007, p. 164

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ownership for the sukuk holders and are discussed in more detail in the following paragraph. For an Islamic perspective, these requirements must be met in a sukuk al-ijarah transaction.

4.1.2 Transactional requirements of sukuk al-ijarah As mentioned above, the SPV is mostly a trust in a sukuk al-ijarah structure. From a transactional perspective, this has the benefits that two important transactional requirements are met. This subparagraph discusses those requirements. First of all, a valid transfer/true sale of the assets from the originator to the SPV is discussed followed by the bankruptcy remoteness of the SPV. These are both important transactional requirements, which should be considered in a sukuk al-ijarah structure.

4.1.2.1 Valid Transfer/True Sale In the context of a sukuk al-ijarah structure, there needs to be a true sale of the assets by the originator to the SPV, which issues sukuk.193 True sale is the official term for guaranteeing that the transfer of rights and receivables is legal, valid, binding, and enforceable. 194 The true sale doctrine refers to the question whether the SPV owns the transferred assets.195 So the main question is: is there a valid transfer of the assets from the originator to the SPV? 196 This question is essential from a Dutch legal perspective as well, although the true sale doctrine does not exist in the Netherlands. The transfer should be such that the creditors of the originator or (in case of bankruptcy) its trustee, will not be able to challenge the title of the transfer. 197 Neither should a court be able to avoid it in bankruptcy or other insolvency proceedings.198 Courts sometimes avoid a transfer in bankruptcy or insolvency procedures. One can think of a fraudulent transfer in anticipation of bankruptcy or a preference payment. Basically, the bankruptcy or insolvency of the originator should not affect the transfer of the assets to the SPV.199 Therefore, the most secure way to deal with the matter is to meet all the requirements for a valid transfer of the assets from the originator to the SPV. In the Netherlands this requirement can be met by meeting the three conditions for a valid transfer under section 3:84 (1) CC. This will be outlined in the next paragraph.

193 194

Abdel-Khaleq & Richardson 2006, p. 418-419 Risk 2007 195 McMillen 2006, p. 452-453; Archer & Karim 2007, p. 176-178 196 Schaafsma et al. 1996, p. 93 197 Schaafsma et al. 1996, p. 93 198 McMillen 2006, p. 452-453; Schaafsma et al. 1996, p. 93 199 Schaafsma et al. 1996, p. 93

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4.1.2.2 Bankruptcy Remoteness Concerning the bankruptcy remoteness of the SPV, one has to concentrate on a reduction of the risk of bankruptcy.200 Bankruptcy considerations weigh heavily, because the bankruptcy of the SPV in many jurisdictions would mean that the assets of the SPV would be distributed in accordance with the law or a court order instead of in accordance with the contractual arrangements. 201 Moreover, there can be obligatory stay provisions pending the SPV bankruptcy, which consequently would interfere with timely payment of the sukuk.202 Finally, bankruptcy proceedings would lead to additional costs such as the costs of liquidation of the assets and of the salary of the insolvency official. It is therefore important to structure the transaction such that initiating a bankruptcy proceeding against the SPV would be as unlikely as possible.203 In jurisdictions where a trust concept is known, the SPV in the sukuk al-ijarah transaction functions as a trust. In that case, creditors of the bankrupt SPV will have no recourse to the trust assets, because the SPV holds the assets in trust for the sukuk holders.204 However, jurisdictions that do not avail of a trust concept, such as the Netherlands, should structure the transaction such that initiating a bankruptcy proceeding against the SPV would be as unlikely as possible and that is sufficient to create a sukuk al-ijarah transaction, which will function properly. In the Netherlands this can be realised with a strictly formulated scope of charter of a foundation, which will have a limited statutory purpose to limit the bankruptcy risks of the SPV and make its bankruptcy as unlikely as possible. This will be discussed in the following paragraph.

4.2 Sukuk al-Ijarah in the Netherlands

When studying the sukuk al-ijarah structure one will notice that it is constructed by transactions that raise certain legal issues from a Dutch legal perspective. As mentioned in the previous paragraph, the originator starts the structure by selling tangible assets to the SPV, whereupon the SPV leases the tangible assets back to the originator. These two legal acts form a SALB transaction between the originator and the SPV. The legal elaboration will be discussed in this paragraph. Furthermore, it is important to qualify the issuance of sukuk in the Dutch legal context. The SPV plays a major role in the sukuk al-ijarah structure, because it
200 201

McMillen 2006, p. 452-453; Archer & Karim 2007, p. 176-178 McMillen 2006, p. 452-453; Archer & Karim 2007, p. 176-178; 202 Abdel-Khaleq & Richardson 2006, p. 418-419; McMillen 2006, p. 452-453; Archer & Karim 2007, p. 176178 203 McMillen 2006, p. 452-453; Archer & Karim 2007, p. 176-178 204 Abdel-Khaleq & Richardson 2006, p. 418-419

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holds the tangible assets in trust for the sukuk holders, after the issuance of sukuk. Both of these aspects will be discussed below.

4.2.1 Sale-and-lease-back

4.2.1.1 The sale of the assets to the SPV in the Netherlands The first transaction in a sukuk al-ijarah structure concerns the sale of tangible assets from the originator to the SPV. Once the SPV becomes the owner, it leases the assets back to the originator. This is a SALB transaction. When facilitating sukuk al-ijarah in the Netherlands, one has to examine how this can be structured. In sukuk transactions, the originators are often governments or big corporations, but they could also be banking or non-banking (Islamic) financial institutions.205 The assets must be of a nature that its halal use is possible.206 The originator sells tangible assets to the SPV and, as discussed above, this has to be a true sale. Therefore, it is important that there is a valid transfer of the assets from the originator to the SPV. Section 3:84 (1) of the Dutch Civil Code (CC) (Burgerlijk Wetboek) contains the requirements for a valid transfer. Due to section 3:84 (1) CC there has to be (1) a valid title, which means that the transaction should be based on a valid legal ground; (2) the party that delivers the assets must have the right to dispose of the assets; and (3) there has to be a delivery of the assets. All three requirements must be met in order to constitute a valid transfer. The requirement of a valid title indicates that the Netherlands has a causal transfer system.207 In a sukuk al-ijarah transaction, the valid title is the purchase agreement between the originator and the SPV, due to which the originator sales the assets to the SPV. Furthermore, the originator must have the right to dispose of the assets; so the originator must be the owner of the assets and, therefore, have the property right of the assets. The last requirement concerns the delivery and this is the most important requirement. The delivery formalities depend on whether the assets are movable property or immovable property. First the movable property will be discussed. Due to section 3:90 CC and section 3:115 CC the delivery takes place by possession provision. In a sukuk al-ijarah transaction, the delivery of movable property can be best structured by the constitutum possessorium delivery (CPdelivery) in accordance with section 3:115 (a) CC. Constitutum possessorium literary means ownership statement and it refers to statement of the transferor to hold the assets for the

205 206

Ayub 2008, p. 393 Usmani 2002, p. 98 207 Peter 2007, p. 1; Van Vliet (Elgar encyclopedia of comparative law) 2006, p. 730

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transferee and not for himself anymore.208 For a CP-delivery, section 3:115 (a) CC requires merely a bilateral statement without handing over the property. Since the assets will be leased back by the originator in a sukuk al-ijarah structure, this form of delivery is most convenient. So as a result of the CP-delivery, the originator can keep the assets in its possession and the originator will hold it for the SPV, because the SPV is the owner after the valid transfer. In this way a valid delivery of the movable property is realized and, therefore, a valid transfer is achieved. However, mostly the transferred assets in a sukuk al-ijarah transaction will be immovable property. Section 3:89 CC describes the requirements for the delivery of immovable property. Section 3:89 CC requires (1) a notarial act or a deed of transfer and (2) the registration of this deed in the public land registers. Meeting these two requirements will lead to a valid delivery of the immovable property. After meeting the above mentioned requirements, a valid transfer of the assets from the originator to the SPV is realized; this means that the assets are sold to the SPV. The true sale is finalized and then the second part of the first transaction of sukuk al-ijarah starts, which is the lease back of the assets from the SPV to the originator.

4.2.1.2 The lease back of the assets to the originator Firstly, one has to determine what the legal qualification of lease is. Lease is an economic concept and although it seems associated with rental, it is not easy to legally qualify lease.209 The concept of lease can be divided in operational lease and financial lease. An operational lease is more comparable with rental due to section 7:201 CC and the risks and liabilities connected to the assets belong to the lessor.210 A financial lease is more comparable with hirepurchase due to section 7A:1576h CC and the risks and liabilities connected to the assets belong to the lessee.211 In case of an ijarah-contract, the lessor bears the risks of damage or liabilities. It is possible to agree with the lessee that the lessee will be liable for the loss or damages which occur due to the usage, but the lessor bears all the regular risks of loss or damages.212 Therefore, sukuk al-ijarah tends to be comparable to the operational lease, which can be qualified as rental due to section 7:201 CC.213 The main difference with the ijarah-waiqtina contract, which is comparable with the financial lease and the Dutch hire-purchase agreement due to section 7A:1576h CC, is that at maturity the originator has to pay a
208 209

Reehuis et al. 2006, p. 197 Reehuis et al. 2006, p. 743 210 Reehuis et al. 2006, p. 743-744 211 Reehuis et al. 2006, p. 743-744 212 Van Rossum 2009, p. 364 213 Reehuis et al. 2006, p. 743-744

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purchase price to buy the assets back.214 While in the ijarah-wa-iqtina contract, and also in a hire-purchase agreement due to section 7A:1576h CC, at maturity the originator being the lessee gets the assets free of charge or for a nominal amount that does not reflect the true value of the assets at such time. 215 So the lease back of the assets from the SPV to the originator in a sukuk al-ijarah structure can be qualified as the Dutch rental agreement under section 7:201 CC in the Netherlands. 216 One consideration is the prohibition of riba and, therefore, it is not possible to charge interest in this rental agreement. However, just like in a Western lease, the amounts of the lease installments are based on the investment plus the profit mark-up, which in general is fixed based on the reference interest rate such as LIBOR.217 Furthermore, the prohibition of gharar does not allow a transaction to take place under the condition that another transaction must take place too, because of future uncertainties. 218 Therefore, the obligation to sell the assets back to the lessee, which is a binding promise called wad, is often laid down in another separate document of the lessor to sell the assets back.219

4.2.1.3 The sale-and-lease-back transaction Another aspect in the Dutch legal context that needs to be discussed in regard to the SALB transaction concerns section 3:84 (3) CC. Section 3:84 (3) CC contains the fiduciaprohibition, which refers to the prohibition of unregulated forms of security interests such as the fiduciary transfer of ownership. Two categories of titles are prohibited by section 3:84 (3) CC. The first one is related to the fiduciary security, as it prohibits the transfer of ownership for security purposes.220 The second once concerns the title which derives from a legal act which does not have the purpose to transfer the assets to the estate of the transferee. The first category is relevant when it comes to the sukuk al-ijarah transaction, because this type of transaction includes a SALB. Section 3:84 (3) CC prohibits the fiduciary security, but the legislator compensated the prohibition of fiduciary security with the introduction of a general

214 215

Van Rossum 2009, p. 364 Van Rossum 2009, p. 364 216 The Temporary Property Hire Purchase Act (Tijdelijke Wet Huurkoop Onroerende Zaken) is not relevant for the sukuk al-ijarah transaction, because the lease back of the assets in the sukuk al-ijarah is an ijarah and can be qualified as a rental agreement due to section 7:201 CC and it cannot, unlike an ijarah-wa-iqtina, be qualified as a hire-purchase agreement due to section 7A:1576h CC. 217 Van Rossum 2009, p. 364 218 Van Rossum 2009, p. 364 219 Van Rossum 2009, p. 364 220 De Groot (Rules for the Transfer of Movables: A Candidate for European Harmonisation or National Reform?) 2008, p. 171

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right of non-possessory pledge in accordance with section 3:237 CC.221 Meijers222 proposed to create a non-possessory security interest and, therefore, objected to the existence of two parallel security rights. 223 There was uncertainty regarding the question whether a SALB transaction was prohibited by section 3:84 (3) CC in the Netherlands. In a SALB transaction the title of sale is used to give the lessor security for the payment of the complete lease price in the form of ownership, while in spite of the sale and the transfer of the assets to the lessor, the economic and legal risk of the assets remains with the lessee.224 Nevertheless, the Dutch Supreme Court decided in a landmark case called the Keereweer q.q. v. Sogelease case that the SALB transaction is not prohibited under section 3:84 (3) CC as long as the scope of the transaction is a true transfer of property and it, therefore, transfers the assets to the transferee without any limitation.225 It would be prohibited if it was used to give the transferee merely security to protect his right as a creditor, since parties are supposed to use the right of pledge or right of mortgage in that case. 226 Section 3:92 CC (reservation of title) and section 7A:1576h CC (hire-purchase) also indicate that transactions such as SALB are allowed under Dutch law.227 In a sukuk al-ijarah the scope of the transaction is a true and valid transfer of the assets from the originator to the SPV. As discussed above, the true sale or valid transfer is even an important aspect of sukuk al-ijarah. The transfer of the assets from the originator to the SPV has no limitations. Neither is the transfer used merely to give the SPV a security to protect his right as a creditor. Therefore, one can conclude that the SALB transaction in the sukuk al-ijarah structure will be permitted under Dutch law.

It is worth mentioning that the beneficial ownership of the sukuk holders is not realised through the transfer of the assets from the originator to the SPV. As will be discussed in more detail later on, the beneficial ownership of the sukuk holders will be realised through the scope of charter of the foundation and through certification of the underlying assets. Since section 3:84 (3) CC concerns the transfer of the assets and the beneficial ownership is not realised through this, section 3:84 (3) CC does not affect the beneficial ownership of the

221

De Groot (Rules for the Transfer of Movables: A Candidate for European Harmonisation or National Reform?) 2008, p. 171 222 E.M. Meijers (1880-1954) was a jurisconsult of recognised competence and the founder of the (new) Dutch Civil Code. 223 Meijers 1958, p. 285 224 Reehuis et al. 2006, p. 95 225 Dutch Supreme Court 19 May 1995 226 Dutch Supreme Court 19 May 1995 227 Dutch Supreme Court 19 May 1995

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sukuk holders.228 Moreover, a valid transfer in line with section 3:84 (3) CC is realised, when the transferee acquires all property law powers of proprietorship. 229 This is the case in a sukuk al-ijarah transaction, because all property law powers remain by the SPV. Section 3:84 (3) is not an impediment for a fiduciary relation whereby the transferee does not enjoy the advantages derivable from the use of the property. These advantages can contractually be transferred to third persons.230 This is also the case in a sukuk al-ijarah transaction, whereby the beneficial ownership is created contractually through certification and the scope of charter of the foundation.

4.2.2 Issuance of sukuk

4.2.2.1 Role of the Special Purpose Vehicle Once the assets have been transferred to the SPV, the SPV will issue sukuk. The SPV is the entity that purchases assets from the originator and funds the purchase price by the issuance of sukuk.231 The creation of a SPV facilitates the structuring and issuance of sukuk to sukuk holders and at the same time the SPV also acts as a trustee for the sukuk holders.232 The sukuk holders are mostly central banks, Islamic banks, and individuals who subscribe to sukuk issued by the SPV.233 In the UK, the SPV in a sukuk al-ijarah structure is always a trust and this has two main benefits. Firstly, in event of insolvency, other creditors of the bankrupt SPV will have no recourse to the trust assets, because the SPV holds the assets in trust for the sukuk holders. So through this, the bankruptcy remoteness is realised, which has to be taken into account as mentioned above. Secondly, a trust structure is needed because sukuk transactions must create a beneficial ownership interest for the sukuk holders in the underlying assets in order to be Sharia-compliant. In a trust structure, the trustee has the legal ownership of the assets, while the beneficiaries have the beneficial ownership. As discussed in the previous paragraph and will be outlined below, transferring beneficial

228

The beneficial ownership of the sukuk holders could also be realised through the transfer of the assets, by using the Dutch concept of ownership at title of management overdracht ten titel van beheer which is called fiducia cum amico. Nevertheless, this concept is not used to realise the beneficial ownership of the sukuk holders. But even using this concept would neither be obstructed by section 3:84 (3) CC, so long the parties intend the SPV to become the legal owner and realise a valid transfer of the assets from the originator to the SPV as is the case in a sukuk al-ijarah. For more on this see: Dutch Parliamentary History, Book 3 (Introducing 3, 5, and 6), p. 1273; Raaijmakers 2006, p. 60. 229 Maatman 2004, p. 75 230 Asser-Mijnssen-De Haan 2001, nr. 474; Kortmann & Verhagen 1999, p. 196; Faber 1996, p. 231-232 231 Ayub 2008, p. 393 232 HM Treasury 2007, p. 12 233 Ayub 2008, p. 393

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ownership of the assets to the sukuk holders is sufficient to meet the requirement of ownership under the Sharia. These two benefits illustrate that the trust concept is appropriate and convenient for a sukuk al-ijarah structure. So far, however, Dutch law does not recognise a trust concept.234 In most structured asset finance transactions the foundation is used as trustee or agent in the Netherlands.235 By using the foundation, a trust-like relationship is created for the investors. 236 A foundation was chosen to issue sukuk to sukuk holders relating to the income derived from certain office buildings located in the German State Saxony-Anhalt in the 2004 Saxony-Anhalt sukuk issuance.237 The foundation has several advantages. A main advantage of it is that it is easy to set up and the compliance costs are generally marginal.238 In the Dutch financial practice, the foundation is the ideal legal entity for a SPV.239 It is an organization with at (special) purpose, in whose assets outsiders do not participate. 240 Contrary to the Dutch BV and NV, there is no tension between the interests of the organization and the interest of the shareholders.241 Since it is the nature of a foundation not to have dividend responsibilities towards her shareholders (because she has no shareholders), the foundation is really convenient and appropriate to focus on a specific purpose that lies outside here self, such as the custody of the assets that are transferred to her. 242 Furthermore, the foundation has significant tax advantages when compared to the Dutch BV or NV.243 However, the foundation does not create beneficial ownership for the sukuk holders neither does it realise the same bankruptcy remoteness as a trust. Both aspects will be dealt with below.

4.2.2.2 Implications of Dutch foundation In the previous paragraph, it was discussed that the SPV, being the trustee in the transaction, should be a foundation when structuring a sukuk al-ijarah in the Netherlands. 244 The foundation cannot create the same bankruptcy remoteness as a trust, but it can make the
234 235

Aertsen 2004, p. 295 Muller & Hooft 2008c 236 Muller & Hooft 2008c 237 Muller & Hooft 2008c 238 Muller & Hooft 2008c 239 Van Houte 2001, p. 76-81 240 Duffhues et al. 2006, p. 289 241 Duffhues et al. 2006, p. 289 242 Van Houte 2001, p. 76-81 243 The foundation is not subject to corporation tax in the Netherlands, if it doest not carry on an enterprise and if it does not enter into competition with (taxable) entrepreneurs. As mentioned above, the tax law aspects of sukuk will not be discussed in this research. For more on this see: Muller & Hooft 2008c; Wessels, Schwarz & van de Streek 2002, p. 210; Van Houte 1994; Duffhues et al. 2006, p. 289. 244 Aertsen 2004, p. 114-115

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bankruptcy of the SPV as unlikely as possible and this is sufficient to structure the transaction in a proper way. When a foundation is used as the SPV, the obligation to manage the transferred assets is based on the scope of the charter of the foundation, i.e. the scope of the charter will state that the foundation will hold the assets in favour of the sukuk holders and that the sukuk holders are the beneficial owners of the assets.245 This gives the sukuk holders the beneficial ownership over these assets and that is sufficient to meet the Sharia requirement that sukuk holders must have a certain degree of ownership of the underlying assets. However, the assets that are transferred to the SPV to be held in favour of the sukuk holders do not create a separation of assets, so there is no split of ownership.246 As a result, the assets will form part of the bankruptcy estate of the SPV in case of bankruptcy of the SPV.247 Then the beneficiaries merely have a personal right against the SPV. 248 Therefore, the scope of the charter should be formulated such that the foundation will merely have a strict limited statutory purpose, i.e. the management of the assets in favour of the sukuk holders.249 Although this does not create a separation of assets, it will limit the bankruptcy risks for the beneficiaries, since the foundation cannot create significant debts, beside debts that are necessary for the management of the assets. 250 However, the risk that the board of the foundation will dispose of the trust assets contrary to the management-agreement is still present. The sukuk holders have at most a personal claim against the SPV and, more importantly, against the director that has transferred the assets contrary to the articles of association of the foundation for damages for failure to perform a contract, because of the mala fide transfer of the assets wrongfully transferred by the SPV. 251 Due to section 6:103 CC there can also be a liability in tort against the third party to whom the SPV has sold the assets, if the third party has performed a tortuous conduct.252 Furthermore, a limited scope of charter due to section 2:7 CC restricts the power of representation of the board, but within the scope of the charter the board has unlimited and unconditional power of representation due to section 2:292 (3) CC. According to section 2:292 (3) CC a further statutory limitation of the

245 246

Aertsen 2004, p. 114-115 Uniken Venema & Eisma 1990, p. 335; Reehuis et al. 2006, p. 98; Snijders & Rank-Berenschot 2007, p. 164 247 Aertsen 2004, p. 111 248 Verhagen (Extending the boundaries of trusts and similar ring-fenced funds) 2002, p. 95; Aertsen 2004, p. 111 249 Aertsen 2004, p. 114-115 250 Aertsen 2004, p. 114-115 251 Verhagen (Extending the boundaries of trusts and similar ring-fenced funds) 2002, p. 95; Aertsen 2004, p. 111 252 For more on the question when a third party has acted unlawfully and, therefore, an action in tort is possible see: Dutch Supreme Court 17 November 1967; Dutch Supreme Court 17 May 1985; Dutch Supreme Court 27 January 1989; Aertsen 2004, p. 112

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power of representation is merely possible so long the law allows it.253 The law, however, nearly gives possibilities to do so.254 Once the board has performed an act of disposal which is contrary to the scope of the charter and the counterparty knew this or should have known it without further research, only the foundation (or its bankruptcy trustee) can make the legal act void as being ultra vires255 according to section 2:7 CC. The sukuk holders are interested parties under section 2:298 CC and can request the court to dismiss the board based on section 2:299 CC.256 Consequently, the new appointed board can make the legal act void as being ultra vires.257 Moreover, the scope of charter of the foundation must meet the requirements of section 2:285 (3) CC, which states that the foundation is not allowed to make payments to the founders or the board members of the foundation and that the payments must serve an ideal or social purpose. These requirements will not form a problem in a sukuk al-ijarah transaction. Firstly, the payments will be made to the sukuk holders and, therefore, the issue of the prohibition of payment to founders and board members is not relevant. Secondly, although the foundation can also be used for commercial purposes and the requirement of ideal and social purpose is interpreted broadly in the literature258, in a sukuk al-ijarah transaction this will not form a problem at all, because the structure is driven by moral, ethical, and religious incentives. Islamic financial instruments are often referred to as moral ways of financing, since they are based on a fair distribution of welfare and risks between the parties and there is always a connection with real economic value in these transactions because of the underlying assets. But even if this will not be regarded to as an ideal or social purpose, it still will not be a problem, because the foundation can also be used for commercial purposes and the requirement of ideal and social purpose is interpreted broadly in the literature.259

4.2.2.3 The issuance of sukuk Then finally, the issuance of the sukuk can be structured in the Dutch legal context. The foundation can issue the sukuk through certification of the underlying assets. There is no definition of certification under Dutch law.260 In the literature, certification is described as an instrument which creates a situation whereby the legal owner holds the assets in favour of the
253 254

Aertsen 2004, p. 114-115 Van den Ingh 1991, p. 192-195; Dijk & Van der Ploeg 2002, p. 176-177 255 Ultra vires literary means beyond the powers and it refers to a legal act that is beyond the power of representation that the board has based on the scope of charter. 256 Aertsen 2004, p. 115-116 257 Van den Ingh 1991, p. 193 258 Aertsen 2004, p. 116; Dijk & Van der Ploeg 2002, p. 15-16 259 Aertsen 2004, p. 116; Dijk & Van der Ploeg 2002, p. 15-16 260 Van den Ingh 1991, p. 16

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beneficial owner.261 So through certification, the beneficial ownership of the sukuk holders can be realised. Therefore, certification is preferred instead of the issuance of bonds in the Dutch legal context. Moreover, an essential feature of bonds is the payment of interest.262 Issuing bonds as sukuk in the Dutch legal context can raise questions in regard to the prohibition on riba and this also indicates that certification is preferred. The certificate is a personal right that gives the certificate holder a right to payment of that what is promised to him by the statutory conditions.263 It is a security that can have different forms and the nature of it will be described in the certification-agreement and in the statutes of the foundation, if the status of the foundation will contain the rights and obligations of the certificate holders.264 This means that the certification-agreement and the articles of association of the foundation can elucidate that the certificates are sukuk. Furthermore, the certification-agreement states that the SPV will pay the lease payments which the SPV receives from the originator to the sukuk holders and that, therefore, the sukuk holders will be the beneficial owners of the underlying assets. The certificates which are issued as sukuk will also state that the sukuk holders are the beneficial owners of the underlying assets, since they will receive the lease payments that the originator is paying to the SPV from the SPV. So certification of the underlying assets to the sukuk holders creates a situation whereby the SPV (being the legal owner) will hold the assets in favour of the sukuk holders (being the beneficial owners). This determines the fact that the sukuk holders will have beneficial ownership in this structure and that is enough to meet the conditions of the Sharia, since the sukuk holders must hold a beneficial interest in the underlying assets.265 It should be noted that the sukuk holders merely have contractual entitlements towards the foundation under this structure.266 Nevertheless, this is not a problem from a Sharia perspective. 267 As described in the first paragraph, the

261 262

Van der Grinten & Teurniet 1964, p. 7; Van der Grinten & Teurniet 1964, p. 86-87 Claes et al. 2009, p. 102; Nibbering 2006, p. 63; Nibbering 2006, p. 65; Baalen 2006, p. 190; Kroeze, Timmerman & Wezeman 2007, p. 78; Ots 2005, p. 79 263 Aertsen 2004, p. 118-119 264 Van Gerven (Tendensen in het economisch recht) 2006, p. 367 265 Box & Asaria 2005, p. 22 266 Aertsen 2004, p. 70 267 It is also possible to create a collateral security structure by providing security interests for the benefit of the sukuk holders over the underlying tangible assets or over the lease payments. This can be realised with a security agent and it is allowed under the Sharia. However, since it is not required from a Sharia perspective and contractual entitlements are sufficient from a Sharia perspective, this will not be elaborated in this research. For more on the possibilities for a collateral security structure under Dutch civil law, see: Rongen (Vertegenwoordiging en Tussenpersonen) 1999, p. 319-349; Aertsen 2004, p. 120-122; Dirix (Liber Amicorum Jacques Herbots) 2002, p. 97-111; Van Houte 2009, p. 40-42; Thiele 2003, p. 27-104; Jarigsma (Onderneming en Integriteit) 2007, p. 138-151; Vermunt (Fiduciaire verhoudingen: Libellus amicorum prof. mr. S.C.J.J. Kortmann) 2007, p. 247-465.

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principle of contractual certainty is at the heart of Islamic law. 268 So certification of the underlying assets is the final step in the sukuk al-ijarah transaction.

5. CONCLUSION

In order to understand Islamic finance, one has to study its background. Islamic finance refers to Sharia-compliant financing and, therefore, it is important to understand Islamic law as well. In accordance with the classical formulation of the sources of Islam there are two classical sources of law: the Quran and the authentic Hadith. The discipline of Usul al-Fiqh, the roots of Islamic law, can be described as the Islamic legal theory. The sources of Islamic law also form a distinguishing factor of the doctrine of Islamic economics. Although Islamic economics has some links with both Marxism and Capitalism, these two ideologies do not completely reflect the ideology of Islamic economics. One of the most developed areas of Islamic economics is Islamic finance. Islamic finance has the same purpose as conventional banking, except that it operates in accordance with the Sharia. Islamic finance distinguishes itself from conventional banking by several important features. The most important two distinguishing principles are the prohibitions of paying and receiving riba, and of the existence of gharar in contracts. Based upon these principles, several Islamic financial contracts have been created, such as the cost plus sale called murabaha, partnerships such as mudarabah and musharaka, Islamic forwards known as salam and istisna, and leasing contracts such as ijarah and ijarah-wa-iqtina. These structures are applied to Islamic financial products. One of the most important Islamic financial products are sukuk. Since there are fourteen possible structures for sukuk, it is not possible to find one overarching legal solution for all types of sukuk and, therefore, these instruments need to be examined on a case-by-case basis. Therefore, merely the sukuk al-ijarah was discussed. The sukuk al-ijarah can be structured under the current Dutch civil law. In essence, the sukuk alijarah can be structured under current Dutch civil law with a SALB of halal tangible assets from an originator to an SPV and certification of these tangible assets by the SPV to the sukuk holders. The transfer of the assets must meet the conditions of section 3:84 (1) CC and the lease back will be due to section 7:201 CC. In accordance with the Keereweer q.q. v. Sogelease case, section 3:84 (3) CC does not prohibit the SALB in a sukuk al-ijarah structure. The SPV can be established as a Dutch foundation. A limited objects clause can result in a

268

Jobst et al. 2008, p. 10

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reduction of the bankruptcy risks of the SPV. The certification-agreement should stipulate that the sukuk holders are the beneficial owners of the underlying assets and, thus, the beneficial ownership of the sukuk holders can be realised through certification. Hence, it is possible to structure the sukuk al-ijarah under current Dutch civil law and no legislative changes are needed. The legal issues that rose in regard to the structure of the sukuk al-ijarah under Dutch civil law were (1) the SALB transaction within Dutch civil law; (2) the concept of leasing within Dutch civil law; (3) the concept of a trust within Dutch civil law and, therefore, also issues in regard to the concept of a trust such as (3a) the bankruptcy remoteness of the trustee, and (3b) the beneficial ownership of the beneficiaries; and (4) certification of tangible assets within Dutch civil law. These legal issues that rose in regard to the structure of the sukuk alijarah are more inherent to the world of international finance and international financial transactions rather than being typical frictions with Islamic law, although the background of these legal issues was Islamic law, because several Islamic principles had to be met in order to make the structure Sharia-compliant. This makes Islamic finance complicated and interesting. Both Islamic law requirements and transactional requirements need to be examined well, before setting up a certain structure. Once this is done, that Islamic financial structure needs to be legally embedded into the law system of a certain jurisdiction. This research also raises other question in regard to the sukuk. Questions that were not dealt with in this research, because it was outside the scope of this research, but that definitely deserve the attention when structuring sukuk. First of all, legal issues in regard to tax law and regulatory law were not dealt with in this research. Both aspects played an important role in the legislative changes in the UK. Moreover, legal questions on the enforceability of the transactional documents, the choice of law, and the enforcement of judgments were not discussed in this research. These issues also play a role in a sukuk al-ijarah transaction and deserve the attention of further research. Furthermore, this research only structured the sukuk al-ijarah in the Netherlands. However, there are fourteen other sukuk structures. An interesting question is how these sukuk structures can be legally adapted under Dutch civil law, e.g. the sukuk al-mudarabah which is an important sukuk structure as well. Another structure which is getting more and more attention in the Islamic finance world is a sukuk securitization. It would be interesting to research the possibilities for a sukuk securitization. In order to mark out the research, it was not possible to discuss these issues in this study. However, some of these issues will be discussed in further research on sukuk.

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Box & Asaria 2005 T. Box & M. Asaria, Islamic finance market turns to securitization, International Finance Law Review 2005-7

El-Gamal 2000 M.A. El-Gamal, A Basic Guide to Contemporary Islamic Banking and Finance, Indiana: ISNA 2000

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Holden 2007 K. Holden, Islamic Finance: Legal Hypocrisy Moot Point, Problematic Future Bigger Concern, Boston University International Law Journal 2007

Ibrahim 2008 A.A. Ibrahim, The Rise of Customary Businesses in International Financial Markets: An Introduction to Islamic Finance and the Challenges of International Integration, American University International Law Review 2008-4

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A.A. Tariq & H. Dar, Risks of Sukuk Structures: Implications for Resource Mobilization, Thunderbird International Business Review 2007-2

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AAOIFI Shariah Board 2008 AAOIFI Shariah Board, Resolutions on Sukuk, February 2008, Bahrain: AAOIFI 2008

Ainley et al. 2007 M. Ainley et al., Islamic Finance in the UK: Regulation and Challenges, London: Financial Services Authority 2007

Cakir & Raei 2007 S. Cakir & F. Raei, Sukuk vs. Eurobonds: Is There a Difference in Value-at-Risk? (IMF Working Paper 07/237), Washington: International Monetary Fund 2007

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El-Hawary, Grais & Iqbal 2004 D. El-Hawary, W. Grais & Z. Iqbal, Regulating Islamic Financial Institutions: The Nature of the Regulated (World Bank Policy Research Working Paper 3227), Washington: World Bank 2004

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HM Revenue & Customs 2008 HM Revenue & Customs, Stamp duty land tax: Commercial sukuk; Consultation Document, 26 June 2008, London: HM Revenue & Customs

HM Revenue & Customs 2009 HM Revenue & Customs, Stamp duty land tax: Commercial sukuk; A response to the Consultation, 12 February 2009, London: HM Revenue & Customs

HM Treasury 2007 HM Treasury, Government sterling sukuk issuance: a consultation, November 2007, London: United Kingdom Debt Management Office 2007

HM Treasury 2008a HM Treasury, The development of Islamic finance in the UK: the Governments perspective, December 2008, London: United Kingdom Debt Management Office 2008

HM Treasury 2008b HM Treasury, Government sterling sukuk issuance: a response to the consultation, June 2008, London: United Kingdom Debt Management Office 2008

HM Treasury & FSA 2008 HM Treasury & FSA, Consultation on the legislative framework for the regulation of alternative finance investment bonds (sukuk), December 2008, London: United Kingdom Debt Management Office 2008

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Kettel 2002 B. Kettel, Islamic Banking and Finance in the Kingdom of Bahrain, Bahrain: Bahrain Monetary Agency 2002 Moodys Global Credit Research 2009 Moodys Global Credit Research, Global Sukuk Issuance: 2008 Slowdown Mainly Due to Credit Crisis, But Some Impact From Shariah Compliance Issues, New York: Moodys Global Credit Research Announcement 2009

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Verhoef, Azahaf & Bijkerk 2008 B. Verhoef, S. Azahaf & W. Bijkerk, Islamic Finance and Supervision: an explanatory analysis, Amsterdam: DNB Occasional Studies 2008

Zaman 2008 A. Zaman, Islamic Economics: A Survey of the Literature (Working Paper 22 2008 of the Religious and Development Research Programme), Birmingham: Department for International Development 2008

Newspapers and press releases

Allen & Overy 2003 Allen & Overy, Allen & Overy Advises on Islamic First (Internet Press Release), 12 August 2003

Muller & Hooft 2008b N.E. Muller & C.P. Hooft, Islamitische bank is veiliger, Financieel Dagblad 10 oktober 2008

Muller & Hooft 2008c N.E. Muller & C.P. Hooft, Benelux: Courting the Islamic investor, Legalweek News <http://www.legalweek.com/legal-week/analysis/1151098/benelux-courting-islamic-investor>

Schouten 2009 E. Schouten, Probeer bankieren eens met de Sharia, NRC Handelsblad 14 januari 2009

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