New rules for financial leases: a potential avenue for Islamic finance?

Law No 124 recently entered into force on the 29th August 2017 and provides new rules for financial leases.

Article 1, subsection No 136 of the law finally introduces a statutory definition of financial lease into our legal system. Indeed, Italian law already had various provisions governing financial leases (for regulatory, accounting, tax and bankruptcy purposes), but it did not contain a general definition of  ‘financial lease’.

In particular, the law defines ‘financial lease’ as the agreement whereby a registered bank or a financial intermediary enrolled with the register set forth by Article 106 of the Italian Banking Law undertakes as the lessor with the lessee to buy or build an asset according to the lessee's choice and instructions and, while the lessee takes the risks relating to the loss/deterioration of the asset, the lessor makes the asset available to the lessee for a given period of time for consideration which takes into account the purchase or construction price and duration of the agreement.

Upon expiry of the lease agreement, the lessee has the option to purchase the asset at a predetermined price, or, in the case of not exercising such an option, must return the asset to the lessor.

The following subsections, up to and including subsection No 140, regulate the termination of a financial lease agreement as a consequence of a serious breach by the lessee.

In particular, in case of termination of the agreement, the lessor is entitled to (i) have the asset returned to himself, and (ii) sell the same.

The proceeds of the sale have to be paid by the lessor to the lessee, after the deduction of the aggregate amount of: (i) the rentals due and still unpaid at the date of termination, (ii) the principal amount (not the interest) of the rentals due from the termination date to the final term of the agreement, (iii) the price for exercising the purchase option by the lessee, and (iv) any costs and expenses related to the recovery and the sale of the asset. It is ambiguous whether these remedies are to be deemed as exhaustive, and whether, as a consequence, penalty clauses are permitt ed in financial leases.

Law No 124 also sets out that the asset sale shall be made on the basis of the value resulting from publicly available market surveys, or, if those are not available, from an evaluation made by an expert jointly appointed by both parties or chosen by the lessor among three professional appraisers.

The law introduces a concept of fi nancial lease which is Riba-based, but when it refers to a consideration which takes into account the purchase or construction price and duration of the agreement, it could probably also allow the structuring of agreements where the rental is determined on the basis of a reasonable rate of return and reference to an agreed benchmark similarly to Ijarah.

Indeed, the purpose of the lessor is to recover its investments plus a fair return on it and this may accrue through the periodic lease rentals plus the sale price of the asset.

This article was first published in Islamic Finance news Volume 14 Issue 47 dated the 22nd November 2017.