The Learned Lessons from Common Law Countries: Towards Implementing

Modern Islamic Security Interest Laws

Sultan Abdulsalam, Faculty member, King Abdul Aziz University, Saudi Arabia. PhD

candidate, University College Dublin, Ireland.

Achieved aims of this article

Investigate specific issues raised by English lending practice called floating charge from different dimensions.

Whether its essence is still valid and should be continued in the eyes of its supporters, court precedents and some common law jurisdictions who followed, or this concept should be abolished as criticized by many legal scholars and court decisions.

Compared with those who disregard to distinguish between fixed and floating charges and instead enacted Personal Properties Securities Acts inspired by the Unites States Unified Commercial Code model, and with those who does not have well established system in place as in most Islamic countries despite the fact they have incomplete commercial and mortgages laws/codes.

Achieved Aims of this article

We could then predict which legal culture is more convenient to Islamic jurisdictions as some of them are considered civil or common law countries with some reference to Islamic principles and a few of them considered as fully-fledged Islamic countries.

To find a proper solution to the continues efforts of several British legal committees discussed this issue in detail, and whether the call for reform in favour of registration system would enhance lending practice or not on a practical level that lead to perfection.

Islamic principles and its financial instruments never been discussed nor used complicated guarantees/security interests, and it is an attempt to interpret several existing common laws and rules to find a viable solution and if it is possible to combine Islamic and non-Islamic lending practices in one transaction on one hand and on the other to advance the securities used for pure Islamic finance instruments/transactions

Major – Fundamental Concepts

All lending transactions involve several types of risks such as liquidity, credit, capital risks.

Risk to a bank or any other financial institution means the likelihood of the happening of an event that may result in loss to the bank.

Credit risk means the chance that a debtor will not be able to pay either the principal or the interest or both the principal and the interest according to the terms of a specific credit or lending agreement

Credit risk management to accommodate assessment, analysis of the degree of risks provided by a lending transaction involving the bank as well as the act of controlling, supervising or monitoring the risk involved in such a lending transaction in order to prevent from crystallising the fear of non-payment of the loan in question.

Major – Fundamental Concepts

Credit arrangements are used for financing, and can be obtained in four main ways: by offering security; by seeking an unsecured loan; by using a sale as a de facto security arrangement or by resort to a third party guarantee

Security taking is the norm in relation to commercial loan arrangements

Major – Fundamental Concepts

The relative bargaining positions

1.Large corporate debtors with unimpeachable credit ratings may insist on loans without security.

2.Even the most powerful debtor is likely to be presented with a choice by the creditor between a certain interest rate in combination with security and a higher interest rate without security.

Major – Fundamental Concepts

The most important use of security are:

Reducing investigation

To extend credit at an appropriate interest rate but is not obliged to calculate the probability of default or the expected value of its share of the borrower's assets in insolvency

Monitoring costs

To deter any misbehaviour by the debtor that might prejudice recovery of the sums owed, but in doing so increase the expected losses to creditors by a greater amount than the expected shareholder gains.

Major – Fundamental Concepts

The charge definition: a security interest created over assets by the company which is the legal owner of the assets (the chargor) in favour of a creditor (the chargee)

In an equitable charge, there is no transfer of title to the property charged although the chargee does have a proprietary interest in these assets.

It could be either fixed or floating. A fixed charge is created over identified property or class of properties which limits the debtor's power of disposal and cannot deal with the property without the consent of the creditor. In contrast, a floating charge is also created over identified property or class of properties, but leaves the chargor free to deal with the charged property in the ordinary course of business.

Distinction between Fixed and Floating Charge and its Importance

In Re Panama, New Zeland and Australian Royal Mail Company, Giffard LJ upheld "But the moment the company comes to be wound up, and the property has to be relised, that moment the rights of these parties, beyond all question, attach.”

There are several conditions for such an asset to be attached which are: 1) A valid charge agreement; 2) The assets are identifiable; 3) The debtor has an interest rights in the assets, and 4) the debtor owes an obligation to the creditor which the charge secures

Distinction between Fixed and Floating Charge and its Importance

The importance to differentiate between fixed and floating charge is vital due to the lower priority of a floating charge. The floating charge ranks behind not only statutory preferential claims but also a later created fixed charge

There are statutory provisions in the Insolvency Act of 1986 in several sections. Beale et al has set them to show their effects on the parties of charge as well as third parties.

1. The floating charge is defined as a charge.

2. Floating charges are required to be registered but registration is not a requirement for all fixed charges.

3. Floating charges made after the Enterprise Act 2002 are made available for the claims of unsecured creditors.

4. Floating charges is subordinated to the costs and expenses of an administrator unlike the fixed charges.

5. The administrator can dispose assets subject to floating charges while it is not permitted for the fixed ones.

6. A floating charge created not for new value in the period prior to insolvency is subject to challenge, and may set aside.

7. A fixed charge can only be avoided if it involves a preference.

8. The impossibility of floating charge holder to appoint an administrative receiver, and under the new rules introduced by the Enterprise Act 2002, the chargee only has a right to appoint an administrator in the interest of all creditors.

The proprietary interest before and after crystallization

 Academic debate place as to what sort of property interest the charge holder of a floating charge has in the charged assets prior to crystallisation.

There are several theories,

First theory: Immediate Equitable Theory, Professor Roy Goode

There are two crucial components of a floating charge: it is a present security interest in a fund of assets which the debtor is left free to manage in the ordinary course of business. Before crystallisation, the chargee's proprietary interest is in the fund of assets, the security interest remaining unattached to charged assets and only attaching to specific charged assets on crystallisation.

Supported by judicial acknowledgement. Slade J. in Bond Worth Ltd, Re stated:

A floating charge remains unattached to any particular property … when it is said to have crystallised; it then becomes effectively fixed to the assets within its scope.

The same approach was also adopted by Lord Walker in Spectrum, where he stated that:

Under a floating charge, by contrast to a fixed charge, the chargee does not have the same power to control the security for its own benefit. The chargee has a proprietary interest, but its interest is in a fund of circulating capital."

Second Theory: Defeasible Charge, Professor Sarah Worthington

A floating charge gives the chargee the same quality of proprietary interest as a chargee with a fixed charge, with the same equitable rights to protect those interests, except that the floating interest is defeasible, while the fixed is not. Defeasance will arise whenever and to the extent that a third party acquires an interest in the charged assets through a transaction which falls within the license to deal

Professor Goode rejects the defeasible charge theory as the statement made by Lord Macnaghten in Yorkshire Woolcombers Ltd, Re can be borne in mind:

A floating charge … is ambulatory in nature, hovering over … the property which it is intended to affect until some event occurs … which causes it to settle and fasten on the subject of the charge within its reach and grasp

LoPucki et al has mentioned that the crystallization of such a charge whether fixed of floating can occur:

By operation of law, automatically in accord with a provision of the security agreement, upon the occurrence of any of four events: 1) cessation of the debtor company's business; 2) the commencement of liquidation/winding-up; 3) the creditor lawfully taking possession of the charged assets; or 4) the appointment of a receiver or of an administrator by a qualifying charge holder.

Or pursuant to contractual notice from the secured creditor to the debtor.

Related Precedents Highlighted the Distinction between Floating and Fixed

Charges

Government Stocks and Other Securities investment Co Ltd v Manila Rly Co Ltd

“A floating charge is an equitable charge on the assets for the time being of a going concern. It attaches to the subject charged in the varying condition in which it happens to be from time to time”

In Illingsworth v Holdsworth or Re Yorkshire Woolcombers Association, his Lordship sought to differentiate between a specific or fixed charge and a floating security:

"A specific charge, I think, is one that without more fastens on ascertained and definite property or property capable of being ascertained or defined; a floating charge, on the other hand, is ambulatory and shifting in its nature, hovering over so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject matter of the charge within its grasp or reach."

One of the most quoted definitions of floating charge characteristics is that of Romer LJ in the same case in the Court of Appeal:

"A floating charge has three characteristics: (1) It is a charge on a class of assets of a company present and future; (2) if that class is one which, in the ordinary course of business of the company, would be changing from time to time; and (3) if you find that by the charge it is contemplated that, until some future step is taken by or on behalf of those interested in the charge, the company may carry on its business in the ordinary way as far as concerns the particular class of assets I am dealing with."

In National Westminster bank plc v Spectrum Plus Ltd, the House of Lords chosen instead to describe the essential characteristic of a floating charge rather than define it. The third characteristic in Romer LJ has been reinterpreted in Re Spectrum Plus Ltd

"In my opinion, the essential characteristic of a floating charge is that the asset subject to the charge is not finally appropriated as a security for the payment of the debt until the occurrence of some future event. In the meantime the chargor is left free to use the charged asset and to remove it from the security." In the same judgment, Lord Scott stated that "if a security has Romer LJ's third characteristic ... it qualifies as a floating charge, and cannot be a fixed charge, whatever may be its other characteristics."

In Agnew V Commissioner for Inland Revenue and also called Brumark Investments

"In deciding whether a charge is fixed or floating charge, the court is in a two stage process. At the first stage, it must construe the instrument of charge and seek to gather the intentions of the parties from the language they have used…. The object of this stage of the process ….is to ascertain.... Once these have been ascertained the court can then embark on the second of these processes which is one of categorization which is a matter of law”

The respected courts over a century have changed its position and overruled several cases to distinguish between floating and fixed charge

The Position of Law Prior Re Spectrum Ltd re the Parties Freedom to Dispose of

Charged Assets In Siebe Gorman & Co Ltd v Barclays Bank Ltd under Siebe

Gorman, a charge was fixed even if the debenture did not prohibit the debtor from withdrawing money from the account into which the proceeds were deposited without the bank’s consent, so long as the other restrictions were present

1. The problem with this decision was highlighted in Spectrum Plus, where the debtor, after paying the proceeds of the book debts into the account, withdrew on the account up to its overdraft limit.

2. The Court also felt constrained to follow Siebe Gorman because that decision had been accepted as correct by the banking industry for 25 years or so

3. Since this decision comes in place and overruling Sibe Gorman with it the basis for the standard English bank debenture, it caused worry amongst bankers and lawyers in the UK

Keenan Bros Ltd, Re

This case shows that it would be insufficient for such a charge to be called a fixed or floating charge with plain terminology or labelling. Moreover, the declared intention of the parties would not also be considered unless the true construction of the debenture in question was in place

It might be argued that a label should be ignored entirely in the characterization process. There are two approaches:

1. Rejected by the House of Lords is that there is a preliminary presumption that the parties intended to create fixed charge; the court then looks to see whether there is anything in the agreement inconsistent with this intention.

2. To view the label as providing some indication of the parties' intention when the court is determining the parties rights' and obligations, if the nature of these is not expressly spelt out by the contract.

The Position of Law Post Re Spectrum Ltd

Re JD Brian.

This case has answered the question of whether the courts will recognise automatic or express crystallisation clauses outside of the traditionally recognised crystallisation events.

Corcoran thinks the decision in Re JD Brian should stand as a warning to those drafting such clauses although there is ostensible judicial reluctance to impose restraints on the ability of parties to expressly dictate crystallising events.

Not only the notice in question, but also the terms of the clause, purported to restrict the company's ability to deal with the assets post-crystallisation.

While the learned judge has signaled judicial acceptance of breach of a negative pledge clause as an automatic crystallizing event, the clause must be drafted in terms that prevent the borrower from dealing with the assets after the breach without express lender approval.

Re F2G Realisations Limited.

This case considered whether an English law floating charge was exempt from the registration requirements of s. 395 of the Companies Act 1985 for the reason that it came within the scope of the registration exemptions set out in the Directive on Financial Collateral Arrangements 2002/47/EC.  

This case is of great importance to practitioners as it is the first English law decision which provides some guidance on the scope of the registration exemptions of the Financial Collateral Regulations

Mcgharth has found the said judgment was unsatisfactory and shed the lights to several difficulties.

There was a problem in the court's approach to the interpretation of Art.2 of the FCD.

If a floating charge like the one under consideration were to be within the FCD then the Directive has driven as he says "a coach and horses through s.395 of the Companies Act 1985 and its legislative successors which nobody has yet noticed

There was some misunderstanding of the meaning of dispossession as Vos J. held, and the difficulty arise from the term itself has no technical meaning in English law.

The reliance of court in reaching its conclusion is one adopted from the work of Professor Beale et al the learned judge failed to appreciate that the authors recognised that negative control could involve either practical or legal restrictions on the debtor's ability to deal with the asset.

The issue of the text of the UK Regulations themselves as they offer a statutory definition of security interest which imports the language of English law into the implementation of the FCD. Based on that, the court erred in holding that the creditor was not in control of the bank account containing the disputed funds.

Countries adopt or transplant the floating charge concept

Malaysia As Malaysia is considered as a common law country, the

distinction between fixed and floating charge can be noticed.

Section 19(10)(c) of Companies Act 1965 empowers a company to borrow money. It also has specific power to issue debentures, give security for loans by charging uncalled capital and granting floating charges over its property.

The concept of a floating charge was accepted in Malaysia through Re Bonds Ltd (1921)

Another case in Malaysia is related to the validity of the automatic crystallization clause which has been discussed in the case of Silverstone Marketing Sdn Bhd v. Hock Ban Hin Tracling Bhd (1998). The court held, in allowing the claimant's claim that there are two (2) types of crystallization, i.e. (i) one that does not require active measures and (ii) one that requires affirmative action.

Hong KongThe first reference to floating charge securities

is to be found in the very first Companies Ordinance (No. 1 of 1865)

Hong Kong courts have traditionally followed the decisions of the English appellate courts on the creation, nature and effects of floating charge without substantial modification through the last 150 years

Scotland It was used to follow the British doctrine and changed it

at later stage to follow the American approach/model.

Several court decisions described the floating charge as in Sharp v Thomson, in both the Inner House of the Court of Session and in the House of Lords as "alien"

Interestingly, the judge explained the legal transplant of floating charge as an unsuccessful experience when he stated

The floating charge was not so integrated. Later, he mentioned that the floating charge cannot fit in with Scottish private law

China as a Civil Law Country who transplanted the concept of floating

charge

It adopted new provisions embodying the essential characteristics of the English floating charge in the country’s first comprehensive Property Law in 2007

Legal scholars who discussed and drafted the model property code focused on the provisions of the German and Swiss Civil Codes with reference to the Japanese and Taiwanese Codes as being analogous to the Chinese system as regards legal culture, values, language and history.

The definition of pledge and lien was similar to that in the common law, however, the definition of mortgage was somewhat different. Furthermore, three articles are all placed within the chapter entitled “Mortgage” in the Property Law, with the implication that the Property Law does not treat the floating charge a creating a distinct type of security device, but rather viewing it as an extension of the existing mortgage regime

Allow mortgages, similar to the common law floating charge, to include future assets, however, the assets that can be appropriated to a floating security are much more limited in scope than in English law. Assets that can be so charged are confined to “present or future manufacturing facilities, raw materials, semi-manufactured goods and products”.

Priority Issues has a stark contrast from the English approach. The Chinese Property Law provides no distinction between fixed and floating charges in terms of priority.

The necessity to import the English floating charge rules to China is debatable as many leading common law jurisdictions have abandoned the traditional fixed/floating charge dichotomy and radically reformed their personal property security regimes in favour of a notice-filing system.

Observations on China’s transplantation of common law floating charge rules contributes to the legal transplant literature by showing the negative consequences of an unsophisticated legal borrowing.

The United Arab Emirates

It does not follow the British doctrine but some scholars thought it might be. The reason for the controversy is that the security contemplated by the UAE Code of Commercial Transactions No.18 “Commercial Code” was enacted in 1993, purported to have certain aspects of those of a floating charge

This law stated clearly in article 2 that in the absence of an agreement between the parties, the rules of custom and other commerce-related laws shall apply.

Otherwise, the provisions applicable to civil matters shall apply. The UAE Civil Code is heavily based on the Jordanian Civil Code which derived its provisions from a number of sources, namely, the French and Egyptian Civil Codes, Al Majallah, and the tenets of Islamic Sharia.

Certain articles made the confusion as the terminology “commercial business” is defined in Article 40 of the Commercial Code include “the elements required for (carrying out) a commercial activity. These elements can be divided into tangible assets which encompass goods, stock, equipment, tools and intangible assets which encompass goodwill, trade name, rights of lease and intellectual property rights.”

Furthermore, the wording of Article 40 purports to reiterate the crucial feature required for establishing a floating charge, namely that the charged property comprises some elements of the business itself as a going concern

A security interest under UAE law can only be created over assets that are ascertained and identifiable at the time of creating such interest and may not be created over assets that change from time to time

The American model and experiences of countries followed

General Overview on the US approach

Section 9 related to secured transaction of the Uniform Commercial Code “U.C.C.” has been an integral component of the great economic success of the United States since the 1950s

Article 9 of the U.C.C. permits both the use of future assets as collateral and the securing of future debts, which allows for the operation of the “floating lien”

As early as 1925, the US Supreme Court rejected the floating charge in Benedict v Ratner. It unanimously held that the creation of a security that reserves to the chargor the right to dispose of charged property was void as against creditors and so the validity of floating charges was not recognised.

With respect to security interest priority dates, the approach taken by the UCC is that the first creditor to file or perfect has priority over creditors who file or perfect subsequently, regardless of when the security agreements were made or the loan proceeds disbursed.

Section 9-210 provides a statutory procedure under which the secured party, at the debtor's request, may be required to make disclosure. However, The information obtainable does not include a copy of the security agreement.

The English concept of "sale in the ordinary course" is broader than the corresponding American concept. Under the American concept, only inventory can be sold in the ordinary course of business.

Both the English and American systems determine the order of priority by assigning priority dates to each competing interest.

The American floating lien is regarded as attached to each specific account or item of inventory. Yet, even if the American floating lien is fully perfected, the American grantor, like its English counterpart, remains free to sell goods that are collateral in the ordinary course of business

Despite their doctrinal differences, the security systems of England and the United States function in essentially the same ways. To understand one of these systems functionally is, in a very real sense, to understand them both.

Other countries experiences who follow the US U.C.C model

Canada, New Zealand and Australia, who have also adopted art.9-style regimes i.e. reforming their personal security regime along American lines.

The New Zealand Personal Property Security Act 1999 is based on a test of characterisation of the assets covered by the charge, not characterisation of the charge itself.

The Australasian PPSAs have made the floating charge largely irrelevant, but still allow secured creditors to take security over assets that the secured creditor expects the debtor to sell.

The ‘ordinary course of business’ provisions — s 46 of the PPSA (Aus) and s 52 of the PPSA (NZ) — are a key part of the statutory structure that supersedes the old floating charge and supporting law.

It is necessary to consider the circumstances of each case, it is neither possible nor wise to formulate a universally applicable definition of ‘ordinary course of business’ This is so even in Ontario, where the different statutory formulation means that the test is the less subjective ordinary course of commercial practice generally, rather than the more subjective particular seller’s ordinary course of business that applies in Australasia

In the leading Ontario decision of Fairline Boats Ltd v Leger (‘Fairline Boats’), the Court suggested:

“In deciding whether a transaction is in the ordinary course of business, the courts must consider all of the circumstances of the sale. Whether it was a sale in the ordinary course of business is a question of fact.”

The New Zealand Court of Appeal said much the same thing

There is also some criticism to Article 9 of the U.C.C.

The very nature of secured transactions makes the subject contentious. At its core, the law of secured transactions must establish priorities among claimants.

Secured lending introduces inefficiencies to the market by encouraging banks to lend to asset-rich companies rather than those companies that have the most potential for growth

Islamic Finance and Security Interest

Basic Concepts

The Alqard Alhassan “Interest-free Loan”.

Commercial transactions and contracts are presumptively permissible, unless there is a clear prohibition. There are three main prohibitions within Islamic finance:

a) Paying and receiving interest is prohibited (prohibition on riba)

b) Uncertainty in contracts must be avoided as much as possible (prohibition on gharar); and

c) Speculation and gambling are not allowed (the prohibition on mayseer and qimar).

Islamic bankers have developed a number of such methods, including murabaha (cost-plus financing), ijara (lease financing), musharaka (partnership finance), mudaraba (venture capital finance), and istisna’a (construction or manufacturing finance),, sukuks (Islamic bonds) and takaful (mutual insurance arrangement).

Islamic finance transactions are structured in such a way that, amongst other things, there is:

(a)a duality of risk between parties as the parties must share risk;

(b)an identifiable and tangible asset underpinning financial transactions;

(c) freedom from unearned income (al-maysir); and

(d)freedom from interest payments (riba).

In complying with these religious principles this means that an Islamic financier is more likely to have an ‘equity’ compared to ‘debt’ investment with a financed project.

Islamic jurisprudence has developed an extensive system of rules governing secured transactions (rahn).

These rules are derived from the following four fundamental sources (referred to collectively as the usul al-fiqh): the Koran, the Traditions of the Prophet (sunna), the consensus of Islamic jurists (ijma), and the application of reasoning by analogy (qiyas). In addition to these primary sources, the following analysis of the Islamic law of secured transactions takes as its starting point the rules regarding rahn set forth in the Majalat Al-Ahkam Al-Adliyah (hereinafter the Majalla),

The status of secured interest in some Islamic jurisdictions

There is some controversy as to whether it is possible under Sharia to transact in relation to future goods or items that did not exist at all at the time of the contract or if this is possible only if certain elements are fulfilled. There are two views in this respect.

1. It is not possible, based on certain sayings of Prophet Muhammad prohibiting the sale of anything that did not exist.

2. The more liberal view is that the reasoning behind this prohibition lies in the inability to “deliver” the subject matter of the contract, which is known in Arabic as gharar, and that the prohibition is not in respect of the future aspect of the transaction per se. Consequently, if gharar is eliminated the reasons for the prohibition no longer exist. Modern civil codes have, for obvious commercial reasons, adopted this rule so that it is expressly allowed to transact in respect of future goods provided gharar is eliminated

Secured lending in Saudi Arabia

The Rahn is defined as a mortgage and pledge that applies to both real property and personal property, immovable and movables, without distinction.

The rahn concepts are possession-based. Annexures covered under Saudi Mortgage Law are: mortgage is affective against all annexures to the mortgaged property (e.g., buildings, plants, services, constructions and modifications), expressly including those coming into being subsequent to deed, unless the mortgagor and the mortgagee otherwise agree.

To comply with the rules of different madhahib “Islamic School of Thought”, different jurisdictions define the types of debt that may be secured.

Thus, in Saudi, the debt secured by the mortgage must be: of a financial nature, a specific amount to be acquired in the future, a secured asset, or a debt to be repaid, such as a conditioned debt or a debt to be established in the future or a potential debt.

Some mega projects in Islamic countries need financing, they sometime take syndicated loans from Islamic and conventional banking/financial institutions.

Although there is not a general prohibition on the taking of security under Islamic law, some scholars object to the English law concept of a floating charge on the basis that the assets that are the subject of the relevant security interest are not specifically identifiable.

This can raise intercreditor issues because the conventional lenders may want as extensive a security package as possible on one hand, and Islamic financiers may want to take security over a specific pool of assets that can be readily identifiable on the other hand.

One of the key principles of Islamic finance is that of certainty. If so then the assets of the obligors will need to be allocated between the different types of financiers for security purposes.

Lawrence and Hillier described how a security agent may hold the security interests under the intercreditor arrangements for the benefit of both the conventional lenders and the Islamic financiers.

1. A conventional lender will not own assets, but will have security interests granted in its favour.

2. Depending on the Islamic facility (such as an ijara or musharaka), an Islamic financier may have title to certain assets. In an ijara financing it will own the leased asset and in a musharaka financing it will own an equity interest in the partnership or joint venture

Islamic Principles of Secured Transaction

Quoting from the drafting committee of the Majalla “Islamic jurisprudence resembles an immense ocean on whose bottom one must search, at the price of very great efforts, for the pearls which are hidden there.”

The Koran, which lays the foundation for the Islamic law of secured transactions in the following verse

1.The phrase “let pledges be given” (fa rihanun maqbuda) is viewed as the cornerstone of the possession requirement.

2. However, the fact that the Koran instructs the faithful to transfer possession of the collateral in the particular circumstances described in this Koranic verse does not necessarily amount to a strict requirement that all security interests must be possessory in order to be effective.

3. The verse does not prohibit the creation of non-possessory security interests in circumstances that differ from those described in 2:283. Nor is the language exclusive in its formulation

Two hadiths that are commonly discussed in relation to secured transactions.

1. One hadith simply states that “the Prophet Mohammed Peace be Upon Him mortgaged his armor for barley grams.” This gives no indication as to whether possession was transferred.

2. Another hadith, does describe the transfer of possession of the collateral to the creditor. The Prophet said, “One can ride the mortgaged animal because of what one spends on it, and one can drink the milk of a milch animal as long as it is mortgaged.” This hadith clearly contemplates a possessory security interest (since the secured party is given permission to ride the pledged animal).

This hadith does not prohibit the creation of non-possessory security interests, but only addresses the ability of a creditor to use collateral in his possession, as well as its fruits.

The Majalla expresses this principle in Article 39 which states that “[i]t is an accepted fact that the terms of law vary with the change in the times.” Article 21 of the Majalla also states that “[n]ecessity renders prohibited things permissible.”

The emergence and rising importance of intangible property, such as intellectual property, payment rights and things in action, has made physical possession impossible for many assets.

The need for non-possessory security interests for the operation of securitizations, project finance, and other types of asset-backed finance transactions

The modern computer revolution has also created new tools that render the possession requirement unnecessary.

Possession requirement should be replaced by a more limited prohibition against the creation of security interests that give rise to gharar.

Allow for the creation of security interests in future assets as long as certain precautions are taken to avoid unacceptable uncertainty regarding the nature of the future collateral.

Such uncertainty can be avoided in a security agreement by including provisions which describe the future collateral in a manner that provides some assurance regarding the range of type, quality, and quantity of the collateral, so that the expectations of the parties are clear and no subsequent surprises leading to disputes arise

Modern Secured Transactions Systems and their Relation with

Islamic Principles

According to Sundahl, he identifies five elements of a progressive secured transactions system:

1. Creation of non-possessory security interests

2. Creation of security interests in future assets

3. Securing of future debts

4. Clear rules which give a secured party priority over competing claimants

5. Prompt enforcement of security interests without a court order.

As modern secured transactions systems allow the use of movable assets (both tangible and intangible) such as equipment, inventory, accounts receivable, cash flows, livestock, crops and others as collateral in exchange for loans. It is, therefore, important to create awareness about the possibility of co-existence between the principles of Islamic finance and the principles of modern secured transactions

Western banks might be reluctant to invest in projects that use Islamic financial structures rather than structures familiar to the banks based on the UCC and other western commercial laws. As a result, Islamic projects can be cut off from western funding. Likewise, western projects can be denied funding from Islamic investors if the financial structure of the projects violates the structures of Islamic law.

Current Security Interest in Islamic Banking Practises: Saudi Arabia Listed Corporations as

example

The Saudi British Bank

Islamic facilities agreement (Murabaha) It aims to finance the Company’s operations (building 3 stores under the name of “SACO World”; partial finance to purchase a land plot to erect the head office building; restoring the Takhassusi Store; building the Sawari Store; financing operating capital, imports and issuance of guarantees in connection with the Company’s business activities; and hedging against trade-related foreign currencies exchange rate risks)

These credit lines are secured under: A demand promissory note signed by the Company, Personal guarantees

Banque Saudi Fransi

Such facilities aim at financing the operations of the Company and enlarging SACO World store in Jeddah:

They are secured under: A demand promissory note provided by the Company, Personal guarantees and Personal guarantee provided by Abrar Global Holding Company

On 15/09/2014G, the Company entered into a future purchase agreement for US dollars against Saudi Riyals, Under this agreement the Company undertakes to purchase USD 3,000,000 (three million United States dollars) on a monthly basis to be calculated on the basis of the prevalent exchange rate on the maturity date of each purchase transaction. This agreement is secured by a promissory note provided by the Company

Saudi Industrial Development Fund and commercial companies with the Company obtain facilities at a sum of SAR 302,600,000 for financing the enlargement of the Company’s factory located in Jeddah on the land plot registered under Deed No 2082) dated on 29/02/1433H.

Guarantees

The Company submitted an application to the Fund to cancel the above-mentioned personal guarantees and the Fund advised that it will consider this application after issuance of the Authority’s approval on the Offering:

Mortgage registered on the land plot owned by the Company in Jeddah under Deed No. (210); dated 04/01/1429H (corresponding to 13/01/2008G) All the land plots, buildings and premises erected or to be erected on the land plots owned by the Company under Title Deeds Nos. 208, 209 and 210, along with the entire factory of the Company, its machinery, equipment, office furniture and all that is related thereto or subsequently obtained for the project.

Credit facilities agreement with Alinma Bank

Financing future sales revolving:

Purpose

To finance 70% of the firm purchase orders from the Company's customers.

Guarantees: Joint guarantee from Lavana Holding Company Joint guarantee from Abdul Kadir Al Muhaidib & Sons Company. The Bank agreed to assign both guarantees Order bond

Facilities Agreement with Arab National Bank

Murabaha Agreement for purchasing different commodities on deferred murabaha basis

Guarantees: Joint guarantee from Lavana Holding Company Joint guarantee from Abdul Kadir Al Muhaidib & Sons Company

The Bank agreed to assign these two guarantees, provided that such assignment shall be effective as of the date of completing the Offering and listing the shares of the Company in the Saudi Stock Exchange as a public joint stock company

Order bond at a sum of SAR 347,500,000 Second-tier mortgage on the Company’s factory.

Facilities Agreement with Bank Al-Jazira

Guarantees

Order bond at a value amounting SAR 60,000,000 (sixty million Saudi Riyals Payment and performance bond from Abdullah Al Muammar at equivalent to 19.46% of the value of the finance and from Lavana Holding Company (formerly, Ibrahim Abdullah Abunayyan Brothers Company) and Abdul Kadir Al Muhaidib & Sons at 35.32% of the value of finance for &… %each of them, and from Emad Al-Muhaideb and Abdullah Abunayyan at equivalent to 4.95 each out of the value of the finance.

The Bank agreed to assign these guarantees, provided that such assignment shall be effective as of the date of completing the Offering and listing the shares of the Company in the Saudi Capital Market as a public joint stock company. Comprehensive all-risk insurance in favour of Bank Al-Jazira at the value of the credit facility.

Brief discussion about the Islamic Bonds “Sukuk”

Sukuk are certificates representing ownership claims in underlying tangible assets. The presence of underlying tangible assets is required within these transactions

A small number of sukuk issuances issued to date have been asset backed, in which the returns due to sukuk-holders depend on the performance of the underlying assets. The sukuk-holders have recourse to the assets which they are able to sell or liquidate if the cash flow from the transaction is insufficient to meet payments due to them.

The risk profiles of asset-based and asset-backed sukuk are very different. In the case of asset-based sukuk, investors are taking credit risk in the obligor, whereas in asset-backed sukuk investors are taking risks in the performance of the underlying assets.

There were defaults by some high-profile sukuk issuances such as the Golden Belt sukuk, the East Cameron Gas sukuk and the Investment Dar sukuk, as well as the potential (although ultimately avoided) default of the Nakheel sukuk.

The focus is on specific types such as Sukuk Istisna and Sukuk Muzara. Where some of these applications/transactions might take a long time, it can be guaranteed with traditional possession assets and non-possession assets as illustrated in this paper.

Even, bankruptcy issues are out of this topic, it is good to highlight that no legal protection and priority provided to Sukuk-holder even in Islamic jurisdictions as no laws enacted in this area unlike the legal protection for conventional bond holder as an example.

Moreover, as most of Islamic jurisdictions follow civil or common law principles in addition to Islamic principles, we have noticed that they follow specific doctrine whether the US or British approaches.

Lastly, other secular jurisdictions where Islamic banks operate or such corporations use security interest in compliance with Sahriah principles, however, no legal basis/protection provided in case of default for Islamic bonds or other Islamic financing modes, so risk can be higher than other their oppositions who use existing laws efficiently

 

Conclusion

The late financial crisis occurred despite the fact several advanced legislations enacted in the security interest.

The use of complicated conventional financial instruments that are not adequately covered banks led to inadequate level of lending or provide loans without sufficient monitoring.

The use of interest in conventional lending were not being able to assist companies especially in cases of defaults as the interest accumulate and corporation may not be able to pay due instalments, then available securities may not suffice.

As interest free lending is available in a limited way from public/governmental finance institutions in some Islamic countries,

1. It can be also used in the corporation world specifically from insiders of such a corporate as long as they have adequate guarantees.

2. Islamic banks should provide them as they can empower the overall economy, however, the use of modern security interest system would lead to better practises like this.

Islamic financial instruments can be backed up with non possessionary assets that we encountered in this article. These types of instruments has no relation with interest. Other instruments can be used on the sharing profit and loss concept, thus once a sufficient rules in place cover security interest, they can have vital rule in lending practises.

With respect to current practises in Mega Projects entail syndicated loans from conventional and Islamic institutions, we believe once this law in addition to adequate bankruptcy law enact, they will facilitate the lending business so conventional banks would accept to lend without imposing interest to reduce lending risk.

We can predict that none of the provided reasons and instruments used in the last two centuries in the west would overcome existing and future issues even if such a regulator change/move to a unified approach and then another crisis may come again.

However, Islamic principles that permit everything unless it is clearly stated in its sources should take ideas and practises that suit it and then another advancement in this area will lead one day and being accepted globally as we encounter the essence and approval of ethical finance in the west day after day.

 

Thank You