structuring sukuk al ijarah in the netherlands

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

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)

[email protected]

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

mailto:[email protected]�

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

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Structuring Sukuk al-Ijarah in the Netherlands

Omar Salah

[email protected]

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 fiducia-prohibition 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.

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

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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.

1 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




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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 al-

ijarah. 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

9 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 al-

ijarah 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 Shari’a. The Shari’a has given rise

to two bodies of Islamic law: ‘Ibadat13

and Mu’amalat14

. Political, economic and social

activities are part of Mu’amalat. So banking and financial activities obviously form part of the

economic activities within the Fiqh al-Mu’amalat. Fiqh is knowledge of the practical

regulations and rules of the Shari’a 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 Qur’an, which was

revealed to the Prophet Muhammad. Some eighty verses of the Qur’an 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 Qur’an, 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 Muhammad’s 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

For more on ‘Ibadat see: Nasr 1999, p. 52-56; Kamali 1991, p. 211; Nyazee 1994, p. 67 14

For more on Mu’amalat 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 Qur’an 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 Qur’an, 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 ra’y, played an important part in the development of

Islamic law. Ra’y, however, has the restriction that it can only be applied to Mu’amalat,

because guidelines pertaining to ‘Ibadat are understood by jurists to be beyond reasoning

whereas the guidelines pertaining to Mu’amalat are subject to reasoning.19

The first

specialists and the Qadis started ra’y 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 Qur’anic

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 Shari’a.

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 Qur’an, 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 ‘Shi’a’.23

The

17

Pearl 1979, p. 5; For examples see: Coulson 1994, p. 24-5 18

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’, ‘Shafi’i’ and ‘Hanbali’.24

And the

three ‘Shi’a’ branches are ‘Ithna ‘Ashari’, ‘Isma’ili’, 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-A’la 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 ‘Shi’a’, 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


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 Qur’an, the Sunna, ijma’, and qiyas. Just like in the other fields of Islamic

33

Al-Sadr 1961; Shubber 2000; Rieck 1984 34

Wilson 1998, p. 46-59 35



Siddiqi 1981, p. 52-53 38


Mawdudi 1966, p. 52-83 40

Siddiqi 1981, p. 46 41



Al-Ba’li 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 Qur’anic 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

Nur 1978, p. 53-5 46

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



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-Mu’amalat, which contains the Islamic rules on transaction.56

2.3.1 Shari’a review board

Most Islamic banks appoint a board or committee of religious scholars who are tasked with

reviewing the bank’s Islamic operations and transactions in order to ensure that they comply

with the Fiqh al Mu’amalat.57

This Shari’a 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 Shari’a rules underlying the contract form.58

The Shari’a review board also

assesses whether business is conducted in a Shari’a-compliant manner59

and it plays a role

that is comparable with the Supervisory Board at a conventional financial institution.60

Most

Shari’a 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

Shari’a 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 Shari’a review boards and, consequently, a product can be considered Shari’a-

compliant by one review board and non-compliant by another.62

Therefore, consensus on this

52


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

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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 Shari’a Standards,

and the Islamic Financial Services Board64

(‘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 pre-

contractual obligation to inform the purchaser about the quality of the goods.73

The Qur’an

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

Shari’a. 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

AAOIFI Overview, http://www.aaoifi.com/overview.html (last visited September 20, 2009) 64

Islamic Financial Services Board, http://www.ifsb.org/ (last visited September 20, 2009) 65

Holden 2007, p. 362 66

Qur’an 2:275 67

Ainley et al. 2007, p. 4 68

Kung 2006, p. 742 69

Qur’an 4:29; Qur’an 2:275 70

Tjittes 2008, p. 139 71

Qur’an 5:1; Qur’an 17:34 72

Qur’an 17:35; Majeed 2004, p. 97 et seq. 73

Tjittes 2008, p. 139 74

Qur’an 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 Shari’a-

compliant. 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 Shari’a scholars have advanced the view that it is permissible to invest

in businesses which are not entirely Shari’a-compliant so long as certain conditions are met:

(1) the principal business activity must be permissible under the Shari’a; (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 Qur’an81

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 year’s 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 Qur’anic 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 Shari’a scholars involved. 78

There are disagreements between Shari’a 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

Qur’an 87:14 82

Aghnides 1961, p. 208 83


Durrani & Boocock 2006, p. 152 85

El-Gamal 2006, p. 11-12 86

Qur’an 2:275; Qur’an 2:276; Qur’an 2:277; Qur’an 2:278; Qur’an 2:279; Qur’an 2:280; Qur’an 2:281; Qur’an

3:130; Qur’an 4:161; Qur’an 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

(nasi’a) and stipulated excess (tafadul).94

So the two kinds of riba in sales are called riba al-

fadl and riba al-nasi’a. Riba al-fadl concerns all sales within a single type with inequality,

with or without delay.95

While riba al-nasi’a 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

87

Vogel & Hayes 1998, p. 84 88

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 ta’ajjal. 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

Author’s own

Riba

Sales

Riba al-fadl Riba al-nasi’a

Liability through sale, credit, or

other transactions

Riba of the period of jahiliyya

Loss for hastening (the period)

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Interest on loans is the forbidden riba al-nasi’a.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 Shari’a

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

El-Gamal 2008, p. 29-58 99

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

Qur’an 2:278; Qur’an 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

- 14 -

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 gharar111

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 Shari’a 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

Olson & Zoubi 2008, p. 47 111

Quran 2:90; Qur’an 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

- 15 -

2.3.3.3 Mayseer and Qimar

Mayseer and qimar are also prohibited under the Shari’a.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 Shari’a-compliant business

and speculates for a return for the investment, is not prohibited under the Shari’a.

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

Qur’an 2:219; Qur’an 5:90 122

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


El-Gamal 2000, p. 10-11 129

Qadri 2008, p. 60

- 16 -

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 rab-

al-maal bears all the losses, because the mudarib does not invest anything. One should not

130

Qadri 2008, p. 60 131

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

- 17 -

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

De Vries Robbe & Ali 2005, p. 365 141

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

Qur’an 28:26; Qur’an 28:27; Qur’an 65:6 150

El-Gamal 2000, p. 13-14 151

Ayub 2008, p. 280 152

Usmani 2002, p. 70-71

- 18 -

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 Shari’a, pure debt instruments are forbidden in

Islam and, therefore, sukuk are structured to generate the same economic effects as

conventional bonds, but in a Shari’a-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 Shari’a,

the underlying assets must themselves also comply with Shari’a, 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

Usmani 2002, p. 70-71 154

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-

- 19 -

therefore, these instruments need to be examined on a case-by-case basis.162

Most of the

structures are Shari’a-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 murabaha-

based 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 Shari’a. 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 finance168

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-muzra’a, 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 Shari’a-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

- 20 -

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

The sukuk al-ijarah is the most important structure. The AAOIFI stated that sukuk al-ijarah is

the most Shari´a-compliant form of sukuk.174

As mentioned before, AAOIFI standards are

widely followed across many countries, so this statement is very valuable. Furthermore,

Moody’s reported that sukuk al-ijarah was the dominant sukuk structure in terms of issuance

171

HM Revenue & Customs 2008, p. 20; HM Treasury 2007, p. 17 172

HM Revenue & Customs 2008, p. 20; HM Treasury 2007, p. 17 173

Author’s own 174

AAOIFI Shariah Board 2008

Transfer of assets

& sukuk proceeds

Sukuk issuance

& sukuk proceeds

Lease back &

periodic rentals

Originator

Periodic payments

SPV Sukuk holders

- 21 -

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 value178

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

Moody’s Global Credit Research 2009 176

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

- 22 -

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 lessee-

lessor relationship.189

181

Dar Al Istithmar 2006, p. 7; Cakir & Raei 2007, p. 4 182

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 Shari’a

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

Shari’a. 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

- 23 -

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 Shari’a 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 Shari’a 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 Shari’a 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 Shari’a. 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 Shari’a, 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

- 24 -

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 Shari’a-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 Shari’a-

compliant. Paragraph one discussed this Islamic principle clearly. The last, and most

distinctive, Islamic principle for sukuk al-ijarah under the Shari’a 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 Shari’a 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

Abdel-Khaleq & Richardson 2006, p. 418-419 191

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

- 25 -

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

Abdel-Khaleq & Richardson 2006, p. 418-419 194

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

- 26 -

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


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. 176-

178 203


Abdel-Khaleq & Richardson 2006, p. 418-419

- 27 -

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 (CP-

delivery) 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

Ayub 2008, p. 393 206

Usmani 2002, p. 98 207

Peter 2007, p. 1; Van Vliet (Elgar encyclopedia of comparative law) 2006, p. 730

- 28 -

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 hire-

purchase 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-wa-

iqtina 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

Reehuis et al. 2006, p. 197 209

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

- 29 -

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 wa’d, 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 ‘fiducia-

prohibition’, 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

Van Rossum 2009, p. 364 215

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

- 30 -

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


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

- 31 -

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 Shari’a-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

- 32 -

ownership of the assets to the sukuk holders is sufficient to meet the requirement of ownership

under the Shari’a. 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

Aertsen 2004, p. 295 235

Muller & Hooft 2008c 236




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

- 33 -

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 Shari’a

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

Aertsen 2004, p. 114-115 246

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

- 34 -

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

Aertsen 2004, p. 114-115 254

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

- 35 -

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 Shari’a, 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 Shari’a perspective.267

As described in the first paragraph, the

261

Van der Grinten & Teurniet 1964, p. 7; Van der Grinten & Teurniet 1964, p. 86-87 262

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 Shari’a. However, since it is not required from a Shari’a perspective and

contractual entitlements are sufficient from a Shari’a 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.

- 36 -

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 Shari’a-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 Qur’an 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 Shari’a. 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 al-

ijarah 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

- 37 -

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 al-

ijarah 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 Shari’a-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.

- 38 -

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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

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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

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Islamic Finance Resources 2009

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A.Al-S.D. Al-‘Abbadi, Al-Milkiyah fi al-shari’at al-Islamiyah, Amman: Maktabat al-Aqsa 1977

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A.Al-H.M. Al-Ba’li, Maqasid al-shari’ah wa-mushkilat al-hajjat fi al-iqtisad, Cyprus: International Institute for

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M.S. Al-Fanjari, Al-Madhhab al-iqtisadi fi al-Islam, Cairo: al-Hai´at al-Misriyat al-´Ammah li-l-Kitab 1986

Al-Fanjari 1981

M.S. Al-Fanjari, Dhatiyat al-siyasiyat al-iqtisadiyat al-Islamiyah, Cairo 1981

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R.Y. Al-Masri, Usul al-iqtisad al-Islami, Damascus: Dar al-Qalam 1989

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Y. Al-Qardawi, Dawr al-qiyam wa-l-akhlaq fi al-iqtisad al-Islam, Cairo: Maktabah Wahbah 1995

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M.B. Al-Sadr, Iqtisaduna, Beirut: Dar al-Fikr 1961

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M.B. al-Sadr, Iqtisaduna, Beirut: Dar Al-Ta’aruf 1980

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Imam 1986

M.K.Al-D. Imam, Usul al-hisbah fi al-Islam, Cairo: Dar al-Hidayah 1986

Kamal 1980

Y. Kamal, Adwa’ ‘ala-fikr al-iqtisadi al-Islami al-mu’asir, Cairo: Majallat al-Da´wah 1980

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S.A.A. Mawdudi, Al-Riba, Beirut: Mu’assasat Al-Risalah 1979

Mawdudi 1966

S.A.A. Mawdudi, Islam aur jadid m’ashi nazariyat, Lahore: Islamic Publishers 1966

Nur 1978

M.M. Nur, Al-Iqtisad al-Islami, Cairo: Maktabat al-Tijarah wa Ta´awun 1978

Rahman 1942

S.M.H. Rahman, Islam ka iqtisadi nizam, Delhi: Nadwat al-Musannifin 1942

‘Uthman 1990

M.M. ‘Uthman, Nazriyat al-infitah al-iqtisadi fi al-Islam, Cairo: al-Dar al-Misriyah li-l-Tab´ah wa-l-Nashr 1990

Yahia 1988

M.H.A. Yahia, Iqtisaduna fi daw’ al-Qur’an wa-l-sunnah, Amman: Dar Amman lil-Nashr 1988

Zahrah 1950

A. Zahrah, Usul al-Fiqh, Cairo: Dar al-Fikr al-Arabi 1950

Zaydan 1967

A.K. Zaydan, Al-Wajiz fi Usul al-Fiqh, Baghdad: Matba’at Salman al-A’zami 1967

structuring sukuk al ijarah in the netherlands

Documents