Islamic Model of Hire-Purchase

By:
Prof. Dr. Mohd. Ma’sum Billah
masum@applied-islamicfinance.com
masum2001@yahoo.com
+6019-3699542

INTRODUCTION

Hire purchase is a tool often used by the financial institutions to help in financing the buying of any goods or equipment. Using hire purchase as the mode, financial institutions such as banks may supply the particular goods or equipment on rental basis. The ownership of the good or equipment will be shared between the bank and the client and the portion of the client will remain to the bank as mortgage until the closure of the investment account. However the possession of the good or the equipment will be in the buyer’s hands for the agreed period of time between the client and the bank. Hire purchase transaction includes the dealing of leasing. However, in hire purchase the corpus of the dealt equipment or good will be transferred at the end of the contract.

Hire purchase as a mode of financing is used both in conventional and Islamic banks. In this paper, we will discuss the significant concept under Islamic hire purchase. We will see in depth how hire purchase can be applied in line with the rules and regulations of Islamic shariah.

Hire purchase under the Islamic concept is actually a synthesis of three contracts:

In the context of hire purchase it is crucial for us to understand in depth all these three contracts. However, this paper will emphasize greatly on IJARAH contract being the main body of hire purchase agreement. Hire purchase is concern with financial lease instead of operating lease. The concept of hire purchase under the rulings of Islamic laws and regulations can be classified under the term of Ijarah Muntahia Bittamleek.

MEANING AND DEFINITION

1.Shirkat

Shirkat is an Arabic word which brings the meaning of partnership. Shirkatul Melk brings the meaning of share in ownership. As an example, when two or more persons supply equity, purchase an asset, own the same jointly, and share the benefits as per agreement and bear the loss in the agreed proportion to their respective equity, this contract is called Shirkatul Melk contract.

2.Ijarah

Ijarah is a term of Islamic Fiqh. It originates from Arabic words Air and Ujrat. These two words bring the meaning of consideration, wages, return or rent. Lexically it means the exchange value, consideration, return, wages, or rent of service of an asset. In a simpler word, to give something on rent. Ijarah can be applied in two different situations. In the first situation, it means ‘to employ the service of a person on wages given to him as an exchange or consideration for the service hired’ i.e. A employs B to work for him as a manager or employee and for the expertise provided by B, A will pay him his wages as the consideration. This type of Ijarah includes every transaction where the services of a person are hired by someone else in exchange for specific consideration.

The second type of Ijarah relates to the usufruct of assets and properties, and not to the service of human being. Ijarah in this sense means ‘to transfer the usufruct of a particular property to another person in exchange for a rent claimed from him i.e. A has a house and rent it to B for a certain monetary value as a consideration. In this context, Ijarah is analogous to the English term ‘leasing’.

Under Accounting and Auditing Organization For Islamic Financial Institutions (AAOIFI) some Fuqaha have defined Ijarah as: Ownership of the right to the benefit of using an asset in return for consideration

The elements of Ijarah :-

The detailed elements are:

Sale

A sale contract is a contract between the buyer and the seller under which the ownership of the property or the goods will be transferred to the buyer at an agreed upon price or other consideration which is equivalent to the value of the property to be paid by the buyer. Thus in Hire purchase agreement, both the financial institution and the client will supply equity in equal or unequal portion for purchase of an asset or property such as land, building machinery, equipment, automobile etc. Both parties will purchase the asset jointly, and share the benefits according to their portion of equity. The portion belongs to the financial institution will then be leased out to the sharing client for a fixed rent at a fixed period of time agreed. At the end of the contract, the financial institution will pass or transfer the ownership of the asset to the client against a fixed price for that portion either gradually part by part or in lump sum within the hire period or after the expiry of the hire agreement.

Ijarah Muntahia Bittamleek

Ijarah Muntahia Bittamleek is an Ijarah contract with the transfer of the asset’s ownership from the lessor to the lessee at the end of the contract through various ways. This is a Hire purchase contract base on the Islamic concept. However, instead of using this Islamic term, we will substitute this name as Islamic hire purchase in the next discussion.

Stages and Types of Islamic Hire Purchase

Islamic hire purchase contract consists of three stages :-

Under the Islamic concept of hire purchase agreement, there are a few types of sale that can be conducted within or at the end of the contract. As per procedure of transfer of ownership and legal title of the leased asset from the Hire ( Financial Institution ) to the Hirer ( client ), the sale contract which maybe of various forms are as mention below.

Islamic Hire Purchase through gradually transfer (sale) of legal title/ownership of the hired asset/property.

It is an agreement which include an Ijarah contract with the promise that the lessor will gradually transfer the legal title and the ownership of the leased asset to the lessee until the lessee has full legal title of the leased asset. Under this mode, the asset or the property is purchase by the two parties (Bank and the client) in equal or unequal participation of equity. The Bank’s portion will be hired to the Hirer for a fixed rent per unit of time and for a fixed period, with the promise that the Hire will sell or transfer the legal title of the hired asset to the Hirer gradually part by part in the proportion of the asset for the consideration paid. The Hirer will then acquire the full ownership of the hired asset from the Hire on payment of the total price at the end of the hire period.

Under this type of sale contract in Islamic hire purchase agreement, the price should be pre-determined at the beginning of the contract. The hirer than shall pay the amount of the price which will be divided by the period of time of hiring so that the Hirer in addition to the fixed rent/rental may pay gradually the proportionate consideration in order to acquire the proportionate part of the hired asset, part by part until he become the full owner of the legal title of the asset.

However, it should be noted that there should be a separate sale contract for each acquisition of share sold to the Hirer or for each payment paid by the Hirer to the Hire and that the amount should be reduced proportionately with the decrease of the Hire’s ownership on the hired asset/property.

If, for any reason the contract is revoked, the Hirer shall share the amount of share of ownership that he has paid on the hired asset which has been transferred to him against his payment and that the remaining part of the legal title shall be with the Hire. This will give justice to the Hirer whose aim is to acquire the asset through payment of rent in excess of the fair rental amount. If any losses arises after the Hire has sold his amount of shares on the hired asset, the losses shall be borne by the Hirer.

Islamic Hire purchase through transfer of Legal title by Gifts (for no consideration)

It is an agreement that involves Ijarah contract whereby the legal title is transferred to the Hirer in the form of gift with no consideration by entering into a gift contract in fulfillment of the prior promise upon the Hirer last settlement of the last installment or by the issuing of a gift deed made on conditional on that last installment. Under this type of Hire purchase agreement, the Hire enters into a contract with a promise to transfer the legal title to the Hirer upon his last payment of the hired asset with no further consideration. The legal title will be transferred automatically without any extra payment.

According to some fuqaha, there are two opinions on whether or not it is permissible to give the legal title as a gift. According to Hanafis, Shafis, Hanbalis, Zaidiyah and Imamiyah, it is not permissible. On the other hand, according to AlHarithi (a Hanbalis scholar) a conditional gift is permissible provided it is on something suitable or accepted. The Malikis are of the same opinion on the permissible of conditional gift.

In order to yield an adequate amount of profit for the Hire, the Hire may use the rental amount which is fixed and agreed upon the commencement of the hire purchase agreement. However, the rental should not be regarded as the price of the leased asset and the legal title of the property shall only be passed to the Hirer on the settlement of the last installment.

Islamic Hire purchase through transfer of legal title (sale) at the end of the hire Period for a Token Consideration

This agreement include :-

Islamic Hire purchase through transfer of legal title (sale) at the end of Hire period for payment of specified amount to the Hire by the Hirer

Under this mode, the Hirer and the Hire enters into a hire purchase agreement with an Ijarah contract. The Ijarah contract states that by the end of the period, the Hire and the Hirer will enter into a sale contract which includes an agreed amount for the hired asset to be paid by the Hirer. At the end of this hire purchase agreement, the ownership and the legal title will be transferred to the Hirer against a consideration which has been agreed upon. It should be note that the sale will be executed under a separate sale contract.

Islamic Hire purchase through transfer of legal title (sale) prior to the end of the hire term for a price that is equivalent to the remaining Ijarah/rental instruction

The hire purchase agreement includes an Ijarah contract with the promise that the Hire will transfer the ownership and the legal title of the hired asset to the Hirer at the time that the Hirer wishes to buy the hired asset. The sale could be done during the Ijarah contract if the Hirer wants to purchase the hired asset. The payment would be the amount of remaining installment of the rent that is due on the hired asset. At the time the sale takes place the Ijarah contract will automatically end and both parties will enter into a separate sale contract to transfer the legal title of the hired asset to the Hirer.

Important Features

Under the Islamic economical concept of Hire purchase agreement, the Hire and the Hirer will enter into a contract whereby both parties will purchase the property at specified equity which could be equal or not and that the equity is a predetermined amount before the commencement of the Hire purchase agreement. The Hire and the Hirer will jointly owned the hired asset according to their share of the equity.

In Islamic Hire purchase, the exact portion of ownership of the asset in accordance with their participation equity should be clearly stated in the agreement. The disclosure of the information should also include the name of owner (may be a third party, besides the Hirer Client and the Hire Bank) that the asset will be registered under.

The portion or the share of the Hire (Bank) will under the disposal/possession of the Hirer (Client) for a fixed period of time and at an agreed amount of rental per unit of time together with benefit and other stipulation which should be paid along with the rent should be clearly stated in the Hire purchase agreement. The Hire deserves the rent paid by the Hirer as the Hirer will gain the benefit from the usufruct of the leased asset.

The rent will not be considered as the price of the hired asset as this is the amount due by the Hirer to the Hire for the usufruct of the portion of the hired asset which belongs to the Hire (Bank).

Under the Islamic economical concept of Hire purchase, the hired asset is not sold to the Hirer by the Hire nor purchased by the Hirer from the Hire, but the Hire promise to sell the asset part by part only, if the Hirer paid the consideration (cost price/equity/agreed upon fixed price) for the asset as per stipulations within agreed upon period on which the Hirer also gives undertakings.

The sale transaction or the transfer of the full legal title or ownership at the end of Ijarah period or upon the request of the Hirer could only be concluded by entering into a separate sale contract between both parties (the Hire Bank and the Hirer Client). When the sale contract is carried out the Ijarah contract will lapse.

The hire contract will be automatically executed as the hired asset is delivered into the Hirer possession in a usable form without any defect that could effect the normal use of the asset.

The sale contract will be effective according to the actual sale and the transfer of the legal title from the Hire to the Hirer. For example, if the legal title is transferred part by part in time, the sale will also be affected part by part with transfer of every share. Due to this, the hire contract for that share will lapse and the payment of the rent will reduced proportionately. At the end of the period, the ownership will be fully transferred to the Hirer and the hire contract will automatically end.

Hire purchase agreement which is practiced under the Islamic economic is a binding contract to both parties, the Hire (bank) and the Hirer (client) and both parties are committed to fulfill or meet their undertakings or obligations in accordance to the stipulated agreement.

Under the perspective of Islamic economic, the Hire (bank) will play three major roles along the period of the hire purchase contract which are the partner, the Hire and lastly the seller, while the Hirer (client) will also plays three main roles in oppose to the Hire, which are the partner, the Hirer and the purchaser.

In the period whereby the Hire leased out his portion of the hired asset to the Hirer, the Hirer will act as a trustee and the asset will be trust property in his hands. He will manage and maintain the trust asset on behalf of the Hire at his own cost except in cases of any accident due to any events which are beyond the Hirer control such as natural calamity/disaster. In the latter case, the Hire will borne the cost after proper investigation within the knowledge of the Hirer.

However the Hirer will be held responsible on any damaged of the hired asset if it is due to his act of corruption, transgression, negligence, default etc and he shall compensate the Hire. It should be noted that the unethical behavior will be under the investigation of the Hire (bank).

In addition, the Hirer may not make any changes or remove the hired asset without having a prior agreement from the Hire. In Islamic hire purchase, any stipulation may be made as long as it does not violates the divine laws of Islam or go against the nature or the requirement of the contract itself. Any valid stipulation is also under the agreement of both parties.

Hire purchase agreement may be of a short-term or long-term period which may be utilized for the expansion of services or production, as well as housing activities. The duration of the hire purchase contract shall not exceed the asset’s useful life. In the practice of our economical industry, Islamic Financial Institution normally will not enter into a hire transactions for asset with useful life less than two years.

Islamic Hire purchase facilitates the Hirer to get benefit from the usufruct of the asset and become the legal owner of it part by part until full ownership is transferred. If for any reason, the Hire purchase contract is revoked prior to the end of the agreement period, the legal title will be shared by both parties in accordance to their respective proportion of the ownership after considering all the previous installment until the time of revocation of the contract.

The economical concepts of Islamic Hire Purchase in contrast to the conventional Hire Purchase practice

It should be noted that there are some basic differences between a hire contracts under Islamic economical concept and those of contemporary ones. Some of these differences are as stated below:

The commencement of leasing/hiring

In most contemporary financial leasing, the Hirer (client) will buy the asset on behalf of the Hire (bank) who is paying the price to the supplier of the asset. The hire agreement will then be executed as soon as the Hire lend out the money to the Hirer irrespective whether the Hirer has paid this amount of money to the supplier or taken delivery of the shall-to-be hired asset. This may means that the Hirer’s liability for the rent starts before taking the possession of the hired asset. Under Islamic Hire Purchase, this agreement is prohibited as it amounts to charging rent on the money given to the client which s nothing but interest. Riba is not allowed in Islam as a Hadith says:

“He speaks of in a dream related to the Prophet (SAW) that there is a river of blood and a man was in it, and another man was standing at its bank with stones in front of him, facing the man standing in the river. Whenever the man in the river wanted to come out, the other one threw a stone in his mouth and caused him to retreat back into his original position. The Prophet was told that these people in this river of blood were people who dealt in Riba (usury).”

Expenses consequent to ownership

In the traditional/conventional Hire purchase agreement, the Hire (bank) is not liable for any costs that incurred in the process of purchase and imports of the asset such as the freight and the custom duty. This is not permitted under the Shariah rulings as any costs incurred before the shall-to-be hired asset is delivered in to Hirer hands shall be borne by the Hire. However the Hire may include all these cost and take them into consideration while fixing the rentals.

Liabilities of parties in case of loss to the asset

As mentioned earlier, the Hirer will be held liable for any loss incurred due to his act of corruption, negligence, transgression etc. He also will be held liable for any wear and tear which normally occurs during the use of the asset. However, the Hirer won’t be held liable in cases that cost lost due to natural calamity or disaster. However in the conventional hire purchase practice, the two situations are not differentiated. This is not permitted under Islamic Shariah as both situations should be dealt separately.

Penalty for Late Payment

In cases where the Hirer is late to pay his due rentals, the conventional Hire purchase agreement requires that he shall pay some amount as a penalty for the late payment. Under the conventional practice, this shall be a method in increasing the income of the Hirer. This is not allowed under Islamic practice. The amount due by the Hirer is considered as a debt and should be subjected to all Shariah rules prescribed for debt. The monetary charge is considered Riba.

“Those who eat Ribâ (usury) will not stand (on the Day of Resurrection) except like the standing of a person beaten by Shaitân (Satan) leading him to insanity. That is because they say: "Trading is only like Ribâ (usury)," whereas Allâh has permitted trading and forbidden Ribâ (usury). So whosoever receives an admonition from his Lord and stops eating Ribâ (usury) shall not be punished for the past; his case is for Allâh (to judge); but whoever returns [to Ribâ (usury)], such are the dwellers of the Fire - they will abide therein.”

“And if the debtor is in a hard time (has no money), then grant him time till it is easy for him to repay, but if you remit it by way of charity, that is better for you if you did but know.”

CONCLUSION

As mentioned earlier Hire Purchase Contract under the concept of Islamic economy may be carried out in various forms:

The major prohibition that involves in the conventional Hire purchase contract is the practice of Riba. Riba an-Nasiah is a type of interest that always arises in the conventional Hire purchase agreement. It is an interest charge on lent money. Below is a simple explanation on the practice of Riba:

“Imam Malik reports on the authority of Zaid Ibn Aslam that in the period of ignorance (pre-Islamic times) interest was changed according to the following scheme. One person had a right to the property of another person. It may have been a general right because of the amount lent or the price of something purchased or in any other form. A time was set when the claim would be settled. When the appointed time arrived the creditor would ask the debtor if he wanted to settle the claim or pay interest with an extension of time. If the claim was settled then there was no increase in the payment. Otherwise the debtor would increase the amount payable and the creditor would extend the period further.”