As Islamic finance continues to grow in the UK, professionals in restructuring and insolvency are increasingly encountering Shariah-compliant structures. Understanding these structures is essential for advising clients effectively and navigating complex legal and financial implications. Below, we explore three of the most common Islamic finance techniques for property financing: Murabaha, Musharakah, and Ijara.
Murabaha – cost-plus financing
What is Murabaha?
Murabaha is a sale with a profit markup, often described as “cost-plus financing.” It involves at least three parties: a financier (typically a bank), a supplier, and a customer. The financier purchases an asset and sells it to the customer at a pre-agreed price, which includes a profit margin. Payment can be immediate or deferred.
How is it different from a conventional loan?
Unlike a loan, Murabaha involves the actual purchase and resale of an asset. The profit margin is agreed upfront, and there is no interest charged, making it Shariah-compliant.
Structure:
- Stage 1: The customer requests a Murabaha and promises to buy the asset if the financier acquires it. The financier purchases the asset from the supplier (first contract).
- Stage 2: The financier sells the asset to the customer, typically on a deferred payment basis (second contract).
Variants include commodity Murabaha, where commodities are traded instead of physical assets, and parallel Murabaha, which can incorporate conventional financing elements.
Common uses:
Murabaha is widely used for asset financing, trade finance, and home purchases (as an alternative to mortgages). It is less suited for long-term financing or floating-rate structures because the profit margin is fixed at inception.
Security position:
Security arrangements mirror conventional finance, with customers granting security over assets to support payment obligations.
Musharakah – partnership financing
What is Musharakah?
Musharakah is a partnership where the financier and customer share profits at predetermined ratios. A popular variant, diminishing Musharakah, allows the financier’s share to reduce over time as the customer buys it out.
How is it different from a conventional loan?
In property acquisition financing, the financier contributes part of the purchase price and holds legal title to the asset. Ownership percentages are set out in the Musharakah agreement, and the customer gradually acquires full ownership.
Structure:
- Both parties contribute to the purchase price, establishing ownership shares.
- The customer makes periodic payments to increase its share until full ownership is achieved.
- For property, the financier typically leases the asset to the customer, who pays rent alongside buyout payments.
Common uses:
Musharakah is particularly suited to real estate transactions, including investment projects and property purchases.
Security position:
The financier retains legal title until the customer completes the buyout. Additional security may include assignment of insurances or holding profit reserves.
Ijara – lease-based financing
What is Ijara?
Ijara is an Islamic leasing arrangement used to finance asset acquisition. It involves three parties: the supplier, the financier, and the customer. The financier buys the asset from the supplier and leases it to the customer for regular rental payments.
How is it different from a conventional lease?
Under Ijara, the financier bears the risk of asset maintenance and insurance. To mitigate this, the customer typically enters a service agreement obligating them to maintain and insure the asset.
Structure
- Stage 1: The financier purchases the asset from the supplier (first contract).
- Stage 2: The asset is leased to the customer (second contract).
- Additional agreements cover maintenance obligations and options for asset purchase or recovery in case of default.
Rental payments are usually quarterly and can be fixed or variable (linked to a benchmark rate).
Common uses:
Ijara is often used for high-value assets such as property, ships, and aircraft.
Why this matters:
These structures differ significantly from conventional loans, particularly in ownership, risk allocation, and security. In insolvency scenarios, practitioners must consider:
- Legal title: Often held by the financier, impacting asset recovery strategies.
- Profit-sharing vs. interest: Calculations differ from conventional debt.
- Contractual complexity: Multiple agreements govern rights and obligations.
