Introduction
Income Share Agreements (ISAs) are a type of alternative financing arrangement. These agreements are financial structures in which an individual or organisation provides something of value (often a fixed amount of money) to a recipient who, in exchange, agrees to pay back a percentage of their income for a fixed number of years. ISAs have gained prominence as an alternative to the traditional student loan system in American higher education, and a number of private companies now offer ISAs for a variety of purposes, including as a funding source for college tuition. ISAs are often considered to be less financially risky to a borrower than a traditional private student loan.
How an ISA works
Unlike traditional loans, which require the borrower to repay a fixed amount of money with interest, an ISA is a contract between the borrower and a lender in which the borrower agrees to pay a percentage of their income for a set period of time after completing their education or program. Here’s how ISAs typically work:
- The borrower selects an ISA provider and applies for funding. The provider assesses the borrower’s financial situation, career prospects, and the potential earning potential of their chosen field.
- If the borrower is approved, they sign an ISA contract with the provider. The contract specifies the terms of the agreement, including the percentage of the borrower’s income that will be paid back, the duration of the repayment period, and any caps on the total amount that can be repaid.
- The borrower uses the funds from the ISA to pay for their education or other expenses.
- After the borrower completes their education or program, they begin repaying their ISA by sharing a portion of their income with the lender. The repayment period lasts for a set number of years, typically ranging from 2 to 10 years.
- The borrower continues to make payments until the end of the repayment period, or until the total amount repaid reaches the cap specified in the ISA contract.
The Pillars of Partnerships in Sharia
Since this concept is fairly recent, a definitive view by Sharia Scholars and Sharia standard-setting bodies has not been expressed as of yet. The question that arises is that can this be considered as a valid partnership and risk-sharing endeavour in Sharia? To answer this, we must first understand how Sharia conceptualises a partnership. The following points are the core pillars of a partnerships:
- A partnership must not infringe the major prohibitions in Islamic commercial law, such as Riba, Gharar and Maysir.
- There must be transparency, clarity, and specification of the inputs by the different partners.
- There must be input from both sides in the partnership; the inputs do not have to be financial; it can be non-financial or mixed, whereby capital is provided by one party and expertise, work and labour by another.
- There must be risk-sharing between both parties such that both will lose out if the outcome is negative.
- A partnership necessitates that there is no debt on one partner payable to the other, rather the gains for the funder and capital provider originates from a business/commercial activity that the partners have a partnership in.
- Returns are generated from economic activity and cannot increase by the mere passing of time.
- Returns and profit-sharing arrangements are based on a percentage of profit, and not a fixed amount of capital.
- One partner cannot guarantee the capital of the other partner.
- All profit must be shared initially with the partners being equally ranked, and no one party has a preference over the other.
- There is a sharing of expenses.
- Debt cannot be the basis of capital input for a partnership, meaning one partner cannot be a creditor to the other, and then form a partnership with the debtor with the outstanding debt as that will be a form of guaranteed capital. Debt is guaranteed and liable.
- Some form of risk must be present to make the profit lawful. Every percent of profit must be earned as a result of being tied to one of the following:
- Capital
- Labour
- Responsibility to work (ḍamānas in the case of shirkat al-a’māl)
The above points are the hallmarks of partnership agreements in Sharia. Although it is not necessary for a new structure to be classed and labelled as a ‘Shirka/Musharaka’ or ‘Mudaraba’, all the partnership arrangements have underlying parallels and principles which reflect what a partnership is in Sharia. Sharia has clear pillars which must be abided by to form any valid or acceptable partnership. These are the Muqtadhayāt al-Aqd (dictates of a partnership contract) and are the Haqq al-Shar’ (rights of the Sharia); they cannot be changed or amended in any partnership contract. Not fulfilling the Haqq al-Shar’ in regard to a contract will make the contract and arrangement voidable (Fāsid).
Why are these important to adhere to? That is because the Sharia has clear underpinning principles of what partnerships are. These principles sync with the overarching philosophy in Sharia for all transactions: Musāwāt. Bilateral contracts in Islamic law are underpinned and governed by a principle known as Musāwāt. Musāwāt refers to a symmetry between the contracting parties in terms of rights, obligations and gain in the contract. No party in a bilateral contract should have an upper hand or an unfair and unjustified advantage. Likewise, no party can gain at the expense of the other. The Sharia promotes a level playing field for parties to the contract.
The Ownership Right and Stake in Sharia Financing
In every structure of Sharia, the capital provider gets a stake or ownership right to one of the following in lieu of the financing:
- Equity
- Ownership of an asset
- Manfa’ah (services)
- Non-financial Rights
- Receivables and a claim
In every form of partnership, the funder owns an asset and equity throughout the period of the partnership, and not a claim against their partner, for example:
- Musharaka – equity stake in the assets of the business.
- Mudaraba – The Rabb al-Mal has ownership of assets purchased by the Mudarib.
- Musaqat – the crops provider owns the crops in the duration of the partnership, and a partnership is realised in the produce.
- Muzara’a – the land is owned by the land provider.
- Mukhabara – The seeds are owned by the provider of the seeds.
- Mugharasa or Munasaba – the land provider owns the land or a share of the land. throughout according to those who permit this transaction.
If it is not a partnership, a financier can have a claim and ownership rights to a debt receivable, such as:
- Murabaha – The Islamic bank is owed a debt receivable after initially owning an asset and selling it with a mark-up.
- Salam – The buyer is owed a non-specified asset which is in the ruling of Dayn.
- Commodity Murabaha – The seller of assets is owned a receivable and claims.
In certain instances, the financier owns Manfa’ah and usufruct, as follows:
- Ijara – the lessee is entitled to Manfa’ah and usufruct, whilst the lessor is entitled to a claim to rental payments by transferring the usufruct it owned.
If a return is being demanded from an investment where the investor does not have any equity stake, nor owns an asset, nor a Manfa’ah or service, nor has a non-financial right, then the only other possibility is that the person has a claim against the other party and is owed a receivable.
What is Debt or Dayn?
It is argued that student loans and income-sharing agreements are not debt. To understand this futher, it is useful to discuss the nature of debts from a Sharia perspective. Dayn refers to debt and gives right to a claim against the debtor. The classical Fuqaha have described Dayn as Māl Hukmi, which means that in the eyes of the law, it will be treated as Māl, although in reality it does not possess the traits of Māl at present. The reason why the Islamic jurists do not treat Dayn as Māl proper in the present is that Dayn is something which is not storable or retrievable at present, rather Dayn is inseparable from the debtor, it is a burden on their conscience. It is due to this inseparability that Dayn has far greater controls than other assets. Dayn cannot be traded by other than the debtor to third parties as there is Gharar in whether the debtor will be able to deliver to this third party. In fact, the creditor is unable to deliver the debt himself as he does not have it with him. Hence, trading it is not permitted. Considering all of the above, Dayn does not qualify as Māl proper in the present but will have the features of Māl in the near future when the debt is claimed [Durar al-Hukkam Fi Sharh Majallat al-Ahkam].
Technically, Ibn Nujaym defined debt as “a binding right and obligation in the dhimma of a person.” Debt is that which is connected to the person, and not the assets. It is a right in personam and a personal right, which in legal nomenclature, refers to rights that are tied to a specific person and are enforceable only against that person, and not tied with assets. It is a burden on the conscience of a person. It is a legal obligation on the legal personality of a person.
If it is argued that there is no Dayn on the student, then the financier has no right to claim anything. The funding would then fall under Tabarru’ and cannot be obliged on the student in the future. Similarly, to argue that the obligation itself is contingent, is a form of Gharar and not permissible. An obligation of a contract cannot be contingent (Mu’allaq), that is the very essence of Gharar. Thus, the obligations in ISAs has already materialised in the dhimma of the student. It is only the repayment which is flexible.
If it is said that there is no obligation and rather the income is the source of payments and not a prior obligation on the student, then what ties the funding to the returns? As it will be discussed shortly, there must be something in the interim that ties the financing to the returns, and it cannot be the dhimma of the student/debtor. If there is no equity, asset or right that ties the financing to the returns, then the only plausible explanation is that the financing is tied to the dhimma of the student, and that is generating an obligation. Otherwise, it will be a Tabarru’ from the side of the financier, which nobody claims. If the funding is Tabarru’, then repayments cannot be obliged on the student in the future through the ISA. The ISA itself negates the concept of a Tabarru’ as it is clearly a contract of exchange. If there is an obligation already, then the only plausible explanation is that the obligation is contingent (Mu’allaq). In that instance, an ISA generates an obligation in the dhimma of the student, however, it is only the repayment which is flexible.
Generic Sharia Observations on Income-Share Agreements
Considering the above, and after reviewing some income-sharing agreements, the following general observations are raised against income-sharing agreements:
- What does the funder own in the interim?
In all the Sharia structures of partnership, there is clear ownership of something in the interim of the partnership and investment. The funder in an income-sharing agreement must also own equity or something. To not own anything at all would mean that on what basis and what aspect is the return coming from? What ties the funding and the return together? If there is no investment or equity in something separate to the beneficiary, then that means that the funding has become a liability and a claim on the borrower. A claim against the borrower is an obligation against the borrower.
If it is said that there is no obligation on the borrower as the repayments are contingent, then does this mean there is no debt at all, or there is a debt, but its repayment is conditional and contingent?
If it is argued that there is no obligation or claim against the borrower, then what permits and warrants a return to the investor? It would be just a Tabarru’ and a voluntary donation; however that is not the case. If there was no debt whatsoever, would it then be a Tabarru’ from the funder’s side? If it was a Tabarru’, then why would the beneficiary be liable to pay anything in return? Hence, clearly, an income-sharing agreement is not a Tabarru’, and an obligation is established on the borrower as a result of this agreement. However, the obligation is contingent. The beneficiary has flexible repayment terms where payment is only due when affordable.
If it is said that there is potential that the funder may not receive anything if the conditions are not met, and therefore cannot be like a guaranteed loan, thus the funder has taken a risk and it is not a loan; The possibility of not being repaid is also borne by a typical lender, which is simply credit risk. This alone does not substantiate any Sharia compliance.
Without any equity or any ownership stake or investment, the only possible interpretation is that the funder has a claim on the borrower against their future earnings, however, that claim is contingent, and the repayments are flexible. If that is the case, then it could be argued that this is a Qard with a flexible repayment setup. Earning more than the funding would potentially then be deemed Riba.
If it is argued that the funder is investing in services and Manfa’ah of education, and not simply providing a debt to the student, then there must be a contract initially with the education provider which outlines all the details of the service. However, this cannot be then resold to the student, as the funder has not even taken any possession or receipt of the service; it is not in his power (Qudra) to deliver this on further. This will then fall under the prohibition of selling something one does not own or possess.
If it is argued that the funder is purchasing a ‘right’ to education and then reselling that right to the student, then the contracts do not reflect that at all. In fact, there is no sale of rights contract and there are no two contracts. And with the absence of two contracts, this type of interpretation will violate the Sharia principles of combining two contracts in one.
If it is argued that the student is the Wakil (agent) and the financing is being done through a Wakala structure, whereby the real beneficiary is the funder, then on what basis and terms does the student benefit from the subject matter? Is there another contract? Where is that contract? In ISAs, there are no such contracts. Again, the same objection would arise as above, that the service is not being delivered by the funder, rather the services are in the ownership and possession of the service provider.
If it is argued that the economic activity is the work being carried out by the student and that is the endeavour which generates the profit share, and the investment was in the education, then even this interpretation has flaws. The education is not equity or an investment in and of itself, it was just a service with an expense that created a liability on the student. The financier, without any additional contracts or structuring, is simply covering the current liability with an agreement of repayment on flexible terms with a mark-up.
- Revenue sharing
Income sharing operate as revenue shares. ISAs share revenue and income on gross basis, and not net; in accounting terms, this involves sharing the top line in an income statement before deducting any expenses. That means that a business can be in loss (this is worked out after deducting expenses), but the investor would still receive capital and a return. This fundamentally goes against any partnership structure, where both parties can only share after considering and sharing some expenses.
When the income sharing is based on the top line only, it protects the investor from being exposed to other expenses and losses, as losses are not factored in. So a capital provider receiving a return based on revenue without accounting for any other expenses would be receiving more and would have a greater advantage over their partner.
Observations Based on Previous Reviews
After reviewing some Income-Share Agreements, we highlight below some common features that we have found in our analysis. Note that not all these issues arise in all of them, some may differ, but they typically have the following mechanics:
- The first year is a fixed monthly payment
In some income sharing agreements, the student is responsible to pay a fixed amount for the first year, and thereafter, from the second year, a payment plan is set out on for a percentage of the average gross monthly income from the past year.
From a Sharia compliance perspective, any income-sharing model must be based on a percentage from the outset without any fixed figure set as repayment.
- The financier is paid from the gross earnings
In partnerships, the financier must bear some of the direct expenses involved and cannot simply take gross earnings. What was observed in ISAs was that the financier was simply receiving payments from the gross earnings.
- Any income qualifies for the sharing arrangement
It was observed that earned income includes all gross income from employment. Examples of earned income are wages; salaries; tips; and other taxable employee compensation. Earned income also includes Gross earnings from self-employment.
This makes it more like a Dayn, and less of a partnership structure. The ISA and the subsequent funding was for a particular course, and not just an advance for any education. To then profit from and benefit from any earnings and income whatsoever which do not have any link to the actual funded course makes it less connected to the ‘investment’, and closer to being a Dayn, where liability to repay is there on income irrespective of what employment is done.
- Liability to pay
We have seen the following clause:
You will make [x] monthly payments unless you first pay us $[xx,xxx] or the equivalent of a x% APR, not including any Late Fees, Returned Payment Fees, or other contingent fees. At the end of the 10-year term, if you are current on your payments but still have an outstanding balance, that balance will be forgiven.
In a true Sharia-based partnership agreement, there can be no liability to repay a certain amount. Similarly, having uncertain thresholds to repay brings uncertainty in the term of the financing which is also against Sharia principles.
- Forgiveness of payments
Some ISAs have a clause whereby the financier ‘forgives’ the outstanding amount. For what is one partner being forgiven for? Forgiveness indicates to the presence of an obligation; if it was a genuine partnership arrangement aligned with Sharia principles, there would be no concept of forgiveness as returns are uncertain and the risk is taken on by the financier. From a Sharia perspective, a partner has no future amount to forgive from the outset, he only seeks a profit which if accrued, creates a claim on the proceeds of the partnership. Anything not accrued is not subject to being forgiven.
- Late fees
ISAs typically have late fee clauses that cover more than just actual expenses. Such clauses are not Sharia complaint. The student is charged late fees if certain payments are not made. These fees are not only covering actual expenses, but the surplus is also received as income and covers opportunity costs typically.
- Prepayments
Some ISAs allow prepayments of the obligation. This prepayment element is not Sharia compliant. If it was a true Sharia compliant arrangement, there can be no concept of prepayment as ‘profit’ or return can only be realised if there was any profit accrued. Hence, prepayment again makes it much more aligned to a Dayn and shows that an obligation existed and that is why prepayments are accepted.
- Early withdrawal
Many ISAs have early withdrawal clauses, which state something along the lines of the following:
Early Withdrawal. If you withdraw or are withdrawn from the Higher Education Institution after the cancellation period, you will still be responsible for the total Funding Amount. Failing to graduate does not absolve you from this Note obligation.
The only time that the funding should be repayable from a Sharia perspective is if there is negligence, wilful misconduct, or breach of terms. Furthermore, entitlement would be to the initial investment amount, and not the entire funding amount plus the profit.
- Growth rates
Some ISAs have ‘growth rates’ attached to them. This reflects the growth in value of the funding obligation over the term of funding from which actual payments are deducted. The value of the funding and the outstanding obligation cannot grow throughout the term. This would be Riba and impermissible. In a Sharia compliant funding arrangement based on partnership principles, growth can only come from actual and economic growth generated, and not merely a growth of liabilities.
- Requirement to repay regardless of work
ISAs generally state that the student ‘may be required to make payments’ if they do not make systematic and sustained efforts to work. Again, this reflects a punitive element. The requirement to repay can be exercised if there was a breach of terms, misconduct, or negligence. Without such breaches, the student cannot be responsible to pay.
Which structure may work?
If a Sharia compliant income share agreement is to be developed, then the most suitable structure seems to be that of Murabaha of rights, with flexible payment arrangements from income as an income share. It would operate as follows:
- The student would initially apply for financing.
- Upon passing the criteria, the student would sign an undertaking to purchase an educational package consisting of rights.
- The student is appointed as the Wakil (agent) of the funder.
- The funder will enter into a contract of Musawama and purchase the rights to the educational services through the student as the agent.
- The student, as Wakil, takes possession of the rights documented and evidenced in the agreement of sale. This will form possession to the rights.
- A Murabaha sale of rights will occur, whereby the funder resells these rights to the student on a deferred basis for a maximum fixed price.
- The repayment terms can be flexible, whereby the funder grants respite and a flexible payment plan that the debt can be paid when the student earns above a certain income.
A similar structure can be developed through Ijara, where the rights are leased after purchase. Alternatively, if the education is packaged as rights, they can also enter into a Diminishing Musharaka. However, this is all dependent upon the educational institute agreeing to develop rights to an educational package and following this interpretation through with all of its correct Fiqh implications.
Conclusion
ISAs are contracts between the borrowers and lenders in which the borrower agrees to pay a percentage of their income for a set period of time after completing their education or program. There is a no formal guidance on ISA agreements by any Sharia standard-setting body as of yet. By considering Sharia principles, we realise that in every form of partnership in Sharia the funder owns an asset and equity throughout the period of the partnership, and not merely a claim against their partner. Income Sharing Agreements seem to breach several Sharia principles and do not reflect a partnership that aligns with Sharia. Even though it is a contemporary structure, it does not grant the funder any equity or rights in the interim. The most plausible interpretation seems to be a claim against the student in the future which is marked up with interest but has flexible repayment plan. There are several other concerns raised on conventional income sharing agreements. If there is interest in developing a Sharia compliant income sharing agreement, it can possibly be done via the financing of rights as the core subject matter with a Murabaha or Ijara structure.