This article considers how Sharia-compliant financing transactions can be structured in Iraq. Islamic banking has grown in Iraq, supported by a dedicated legislative framework and demand from businesses and individuals who prefer financing consistent with Islamic principles. Islamic finance structures differ from conventional loans: instead of lending money at interest, the financier typically buys and sells assets, leases them or participates in a venture, earning a return through profit, rent or a share of profits.
These structures raise legal questions that conventional loans do not. Ownership of assets may pass to the financier, registration and tax consequences may arise, and the rights of the parties on default depend on the nature of the contract. Structuring a transaction that is both Sharia-compliant and legally robust under Iraqi law requires coordination between legal advisers, Sharia advisers and the financier’s Sharia supervisory board.
The Islamic Banks Law No. 43 of 2015 governs the licensing and operation of Islamic banks in Iraq, including the requirement for a Sharia supervisory board and the types of activity Islamic banks may undertake. The Banking Law No. 94 of 2004 and the Central Bank of Iraq Law No. 56 of 2004 apply alongside it, and Central Bank instructions address Islamic banking practice. The Iraqi Civil Code No. 40 of 1951 governs sale, lease, partnership, agency and security, and its provisions, many of which draw on Islamic jurisprudence, provide the legal basis for the underlying contracts. The Real Estate Registration Law No. 43 of 1971 governs transfers and leases of real estate.
Choosing the appropriate structure
Different structures suit different purposes:
- Murabaha. The financier buys an asset and sells it to the customer at cost plus an agreed profit, payable in instalments. Commonly used for asset purchases and working capital.
- Ijara. The financier buys an asset and leases it to the customer, with rental payments. An ijara ending in ownership transfers the asset to the customer at the end of the term.
- Musharaka. The financier and customer jointly contribute capital to a venture and share profits according to an agreed ratio and losses according to capital contributions. A diminishing musharaka allows the customer to buy out the financier’s share over time.
- Mudaraba. The financier provides capital and the customer provides management, with profits shared and losses borne by the capital provider except in cases of misconduct.
- Istisna. The financier commissions the manufacture or construction of an asset for delivery to the customer, often used in construction and project finance.
The choice should reflect the purpose of the financing, the nature of the asset and the parties’ risk allocation.
Addressing ownership and possession
In murabaha and ijara, the financier must own the asset before selling or leasing it. This raises practical questions: how title will pass to the financier, whether registration is required, who bears risk while the financier owns the asset and how possession is managed. Where the financier appoints the customer as agent to purchase the asset, the agency should be documented and the sequence of purchase and sale clearly recorded.
For real estate, transfer to the financier and back to the customer may involve registration fees and taxes. The parties should consider these costs and whether structures such as ijara can avoid double transfers. Real estate advice in Iraq can advise on registration requirements for Islamic finance structures.
Taking security
Islamic financiers commonly take security in the same forms as conventional lenders: mortgages over real estate, pledges over movables and shares and personal guarantees. Security must be consistent with Sharia principles and with Iraqi law. In ijara, the financier’s ownership of the leased asset provides inherent protection, but additional security may still be required.
Managing late payment
Sharia principles generally prohibit charging additional profit on late payments as a source of income for the financier. Islamic financing documents commonly address late payment through charity undertakings, under which the customer pays an amount to charity, or compensation for actual loss where permitted by the Sharia board. These provisions should be drafted carefully to be both Sharia-compliant and enforceable.
Handling default and restructuring
On default, the financier’s rights depend on the contract. In murabaha, the financier has a debt claim for the unpaid sale price. In ijara, it can terminate the lease and recover the asset. In musharaka, it may be able to require the customer to buy its share or sell the venture’s assets. Restructuring may be more complex than for conventional loans, because increasing the amount owed on a murabaha debt in exchange for extended time may raise Sharia concerns. Litigation and dispute resolution advice in Iraq can assist with enforcement of Islamic finance contracts.
Obtaining Sharia approval
Each structure and its documentation should be approved by the financier’s Sharia supervisory board. The board will review the sequence of transactions, the terms of each contract and the treatment of late payment and default. Legal advisers should work with the Sharia board to ensure that changes requested for Sharia reasons do not undermine legal enforceability, and vice versa.
Considering tax and regulatory issues
Islamic structures may involve multiple transfers of assets, potentially triggering taxes or fees. Profit earned by the financier may be characterised differently from interest for tax purposes. Tax advisory services in Iraq can assess the tax treatment of Islamic finance structures. Regulatory capital and classification rules for Islamic financing may also differ from conventional loans.
Combining Islamic and conventional financing
Some transactions combine Islamic and conventional funders, for example in large projects where an Islamic bank and conventional banks lend alongside each other. These structures require careful coordination. The Islamic tranche will use structures such as ijara or istisna, while the conventional tranche uses interest-bearing loans. Both tranches will want to share security and rank equally.
An intercreditor agreement can coordinate the tranches, covering the sharing of security, voting on enforcement and the application of proceeds. It should be reviewed by the Islamic financier’s Sharia board to confirm that sharing arrangements and common terms are acceptable. Particular attention should be given to the treatment of late payment amounts and to any provisions that would require the Islamic tranche to receive or pay interest.
Where an asset is owned by the Islamic financier under an ijara structure, the conventional lenders may not be able to take security over it directly. The structure should provide an alternative, such as security over the lessee’s rights or an agreed sharing of proceeds from the asset.
Illustrative example. An Iraqi manufacturing company wants Sharia-compliant financing to buy new machinery from a foreign supplier. An Islamic bank appoints the company as its agent to buy the machinery, takes title on delivery and then sells it to the company under a murabaha contract with payment over three years. The bank takes a mortgage over the company’s factory and a personal guarantee from the main shareholder. The documents include a charity undertaking for late payments, approved by the bank’s Sharia supervisory board, and a clear record of the bank’s ownership before the sale.
Conclusion & how Etihad Law Firm can help
Islamic finance in Iraq offers businesses a range of Sharia-compliant structures, each with its own legal requirements. Careful attention to ownership, security, late payment, default and Sharia approval ensures that transactions are both compliant and enforceable.
Etihad Law Firm advises Islamic banks, businesses and investors on structuring and documenting Sharia-compliant transactions in Iraq. Our commercial team works with Sharia advisers to deliver structures that meet both legal and Sharia requirements.