French law techniques serving Islamic finance

11 minute read
07 July 2014

Islamic finance is booming. Sharia law essentially prohibits investments in certain sectors considered as illicit ("haram") and the payment and receipt of interest ("ribha").

Islamic finance enables investors to develop and finance projects without infringing these prohibitions. There are various sharia-compliant techniques available to investors that can be implemented under French contract and corporate law, which we outline below. We also discuss how these techniques fare against French banking monopoly rules.

French contract law techniques

Sales with deferred payment of price

French contract law can be used to implement a "murahaba" transaction, a sale which transfers ownership of an asset immediately but with deferred payment.

Both the classic and the "tawarruq" types of "murahaba" can be implemented in France, each being covered by a tax instruction purporting to make it as tax-neutral as possible:

(a) Classic "murahaba"

In a classic "murabaha", the investor asks the financier to purchase the desired asset (for instance, a property or shares in a property-owning company) and to immediately resell it to the investor for a price payable in future instalments and for an aggregate amount that exceeds the price paid by the financier (i.e., with a "markup" corresponding to a profit for the financier).

The purchased asset can be used as collateral for securing the payment of its purchase price. French law allows a "vendor's lien" which is cheaper to perfect than a contractual mortgage (i.e., by almost 0.8% of the value of the property compared to a contractual mortgage) but just as effective.

An orphan company can also be interposed between the investor and the financier, preserving the latter from the legal risks associated with the roles of (one-split-second) owner and vendor. If the financier is a conventional bank, it can grant a loan to such an orphan company which may then use the loan proceeds for buying the asset and reselling it under a "murabaha" to the Islamic investor - typically the orphan company's claim for the payment of the price will then be security-assigned to the bank as security for the orphan company's own obligations as borrower.

The disadvantage of this type of transaction, when it concerns real estate property, is the additional cost of 0.715% in land tax associated with a double transfer of land. This type of transaction is, however, suitable for an acquisition of shares in an unlisted property-owning company and many such investment transactions have been made in France.

(b) "Tawarruq"-type "murahaba"

A "tawarruq"-type "murabaha" is a deferred-price sale of liquid assets such as financial instruments or commodities (except gold or silver) that will be sold to the investor. The latter will resell them immediately to a third party and, with the proceeds of this sale, buy the investment asset the investor actually wants.

If such financial instruments or commodities were resold to the same financier, this would be characterised as a "bai al inah" transaction, which is not considered sharia-compliant by many Muslim scholars in the Middle East (it is more acceptable among Malaysian scholars).

In a "tawarruq", the financier usually bears the market risk associated with the possible loss of value of the liquid assets - e.g., "Dow Jones Islamic Index" ETF securities - between the time of their purchase and the time of their resale to the investor.

This type of transaction has been used in France for purchasing real estate, without the additional cost of 0.715% in land publicity tax associated with a "murabaha" over the property itself.

Sales with deferred transfer of ownership

Under French law, it is possible to structure a sale so that the price is paid before the asset's ownership is transferred, with a discount enabling the financier to realise a profit economically equivalent to interest.

Such a deferred-transfer-of-ownership sale can be used for implementing an "istina" transaction, whereby the financier will make advance payments during the construction of an asset but will acquire ownership only when the asset is completed, and then either sell it to the investor under a "murabaha" or lease it to the investor under an "ijara".

It can also be used for a "bai a salam" transaction, where the financier will purchase assets from a business so that the latter may use the advance payments for financing its working capital.

Finance leases

French law authorises finance lease transactions, where the financier purchases the asset that the investor wants (either from a third party or the investor itself), leases it to the investor in consideration of rents and gives the investor an option to purchase the leased asset for a price that diminishes with time and eventually reaches a symbolic amount such as one Euro. Rents are calculated to be equivalent to the fixed instalments of a constant payment loan (interest payment and principal repayment), while the declining purchase price is calculated to be equivalent to such a notional loan's outstanding principal at the relevant time.

When it involves a real estate property, this technique has the advantage of avoiding the additional cost of 0.715% in land publicity tax, inasmuch as the transfer taxes that apply when the purchase option is exercised are calculated on the exercise price, which is a symbolic amount at the end of the finance lease. This technique also avoids the cost of a mortgage (up to 1.3% of the loan amount, or 0.5% if the mortgage is a purchase-money security interest).

Hence an "ijara" (lease) transaction could be implemented in France, making sure of course that the risk of destruction (and cost of insurance covering this risk) remains borne by the financier for sharia-compliance purposes, unlike in a traditional finance lease.


Whereas the techniques described above are designed to have the financier bear risks similar to those of a lender, a financier can also decide to invest in a project by injecting equity alongside the investor.

French corporate law allows for companies to receive contributions in cash, in kind or even in services from their investors, and shareholder agreements can be structured so that benefits generated by a project are first applied to the repurchase of the financier's equity.

So in France it is possible to implement sharia-compliant equity co-investments like "musharaka" or even (if the investor is clever) "mudaraba" transactions. Investments can also be structured to allow a "moutanakissa", where the share of the financier diminishes faster than the investor's share.

French corporate law

French corporate law allows for French companies to issue bonds with various features.

A French corporate bond could take the form of a "sukuk", characterised by a remuneration based on the performance of an underlying asset (assuming that the relevant sharia board does not require the holder of the "sukuk" to have an in rem right in the asset itself, or if it requires this, that it considers the in rem right resulting from a security interest in the underlying asset to be sufficient - otherwise the use of a French trust could be necessary).

It is also possible under French law to structure a "sukuk" bond so that it mimics the financial features of an interest-paying bond. This is done in two ways. First, by stipulating provisional payments based on a target profit rate, which may be fixed or equal to the aggregate of a variable index rate such as the EURIBOR (or the new Islamic Interbank Benchmark Rate) and a margin (plus possibly an additional payment akin to an amortisation repayment). Second, being bundled with a sale option for an exercise price equal to the price originally paid by the financier for acquiring the "sukuk" minus any sums paid by the "sukuk" in excess of the target profit rate (being akin to amortisation repayments) or, if required by the sharia board that approved the "sukuk", an exercise price corresponding to the net value of the underlying asset.

French banking monopoly rules

In France, it is illegal for any person other than a credit institution or financing company to, subject to certain exceptions, carry out on a regular basis "credit transactions" as defined in the French Monetary and Financial Code.

A credit transaction is defined as any act whereby a person, for profit, puts or undertakes to put funds at the disposal of another person or who issues, in the interests of the latter, a signed commitment such as an endorsement, a surety or a guarantee. The definition also provides that credit transactions encompass finance leases and, in a general manner, any lease transactions with a purchase option.

Consequently, although an Islamic bank should ideally be licensed as a credit institution (in France or elsewhere in the European Union) or as a financing company (in France) in order to carry out the widest array of finance transactions, it is nevertheless possible for a foreign Islamic bank to implement certain Islamic finance transactions on French territory without such a license. It also does not need to "extra-territorialise" the transaction in order to circumvent the territorial scope of French banking monopoly rules, or operate in France on a "non-regular basis", both of which can be risky strategies.

For starters, non-French Islamic banks can implement "musharaka" transactions in France without infringing French banking monopoly rules, given that these are equity rather than debt transactions.

Non-French Islamic banks can also subscribe "sukuks" structured as bonds issued by French companies without infringing the monopoly rules. The issuance - and therefore the subscription - of financial instruments is expressly separate from the French banking monopoly rules (with a new exception for financing companies seeking to refinance themselves, although this is not a concern for non-French Islamic banks).

A "murabaha" could also arguably be carried out in France without a French or European bank license, as the definition of "credit transaction" requires a drawdown of funds, which is not the case in a "murabaha". Moreover, one of the exceptions to the French banking monopoly rules expressly enables businesses, "whatever their nature", to grant payment deferrals in the exercise of their professional activity. This is similar to what a financier does when selling an asset and asking for the deferred payment of the price in a "murabaha" transaction.

In fact, the only type of transaction out of those discussed above that a foreign Islamic bank could not carry out in France without a license is an "ijara" with a purchase option, as finance leases and more generally leases with purchase options fall within the scope of French banking monopoly rules. This could, however, be circumvented by replacing the purchase option with a sale with a deferred effect (lease-sale) in a given transaction.

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