Are Student Loans a Mudharabah (investment contract)?

Question:

A fatwa by Shaykh Haitham al-Haddad is being circulated that Student Loans are a Mudharabah and that it is permissible.  Can you please clarify this? The fatwa can be seen on:
http://www.islam21c.com/islamic-law/on-sh-haithams-student-loans-fatwa/

In the Name of Allah, the Most Gracious, the Most Merciful.

As-salāmu ‘alaykum wa-rahmatullāhi wa-barakātuh.

Introduction:

This is an academic discussion on the subject of student loans being a Mudharabah ensuring respect and reverence is preserved for every scholar and opinion. Respect for other scholars and their opinions is part of our tradition and heritage in scholarly discussions. This research is not discussing or debating the permissibility or impermissibility of student loans, that is an issue which the senior scholars are requested to address in light of fiqh, the lack of viable alternatives and the current situation of Muslims.  This research instead highlights the differences between a student loan and a Mudharabah.  The discussion is split into three:
1)      What is a Mudharabah and what are tuition fees
2)      The differences between a Mudharabah and student finance
3)      The possible fiqh perspective of student finance

What is a Mudharabah?

Mudarabah is an equity investment between a capital provider, and an entrepreneur, whereby the entrepreneur can mobilise the funds of the former for business activity. The entrepreneur provides expertise, labour and management earning him a share in the profits.
In a Mudharabah, a partnership is created when profits are realised.  The profit sharing ratio is pre-agreed by mutual agreement.  In the event of loss, the capital provider solely bears financial loss whilst the entrepreneur suffers loss of effort and time.
Others have described Mudharabah as a type of partnership for profit which is structured so that one partner provides capital and the other provides labour and expertise. The partners will share the profit (positive results) according to the terms and conditions agreed to at the time of contracting typically at a mutually agreed ratio.
 

What are tuition fees?

The following is from the Student Loans Company website[1]:
The Tuition Fee Loan is a non-income assessed loan to meet the cost of tuition fees. It is payable to the university or college  in three instalments. Payment is made when confirmation is received from university or college that the student is in attendance at the start of each term.
The amount of tuition charged is dependent on both the:

• country of study – each of the devolved governments are responsible for setting the maximum tuition fees rate within their territory
• university or college  – who charge a fee rate up to the maximum set by their government (this excludes private institutions who can charge more)

The maximum Tuition Fee Loan available to a student will be the lesser of the two.
Any costs which are in excess of this will need to be paid by the student directly to the university or college.
All Tuition Fee Loans are repayable and accrue interest at the same rate as the Maintenance Loan.
 

The Differences Between a Mudharabah and a Student Loan

1)      Tuition fees are not handed over to the student

For a Mudharabah to be valid, the majority of schools and jurists agree that it is a pre-requisite that all the capital must be handed over to the entrepreneur (Mudharib)^[2].  Only the Hanbali school cite a difference of opinion in this regard.  However, in student finance, students do not receive tuition fees.  They only take receipt of the maintenance loan.  Instead, the Student Loans Company (SLC) pays the university directly after a student registers onto a course[3].  Hence, student finance fails to fulfil this criteria of validity.
If we were to consider a student loan to be a Mudharabah, it would mean that the capital provider (Rabbul Maal) is providing both capital and labour.  The entrepreneur (Mudharib) does not perform labour with the capital.  Whereas, in a classical Mudharabah, capital is from the Rabbul Maal and labour is a performance of the entrepreneur (Mudharib).  Therefore, student finance cannot be a Mudharabah.

2)      Ownership of capital

In a Mudharabah, the capital provider remains owner of the funds throughout the Mudharabah operation.  Here, the Student Loans Company loses ownership of the capital upon payment to the university.  Therefore, are they investing in a student or rather making a payment on his behalf in lieu of a future repayment?

3)      Tripartite relationship in student loans

A Mudharabah is a bipartite treaty between a capital provider and an entrepreneur.  In student finance, there is a tripartite agreement between the Student Loans Company, student and university.  Thus, the two are inherently different.
The relationship in a Mudharabah between the capital provider and the entrepreneur evolves throughout the operation of Mudharabah.  A typical Mudharabah initiates as a wadi`ah (safekeeping), evolves into agency (wakalah), followed by shirkah (partnership) upon profit realisation.  The relationship between the two parties is as a result of the entrepreneur’s possession of the capital.

In student finance, the above never materialises as the student does not possess the capital.  The question is, what is the relationship and legal nexus between the three? One party is making a payment on behalf of another to a third party in student finance.  Hence, student finance which has a tripartite entity relationship is integrally different to a Mudharabah which is based on two entities and not necessarily two people.

4)      Mudharabah is not a service to the entrepreneur (Mudharib)

In a Mudharabah, the entrepreneur (Mudharib) is not a beneficiary of services, rather, he provides services and invests labour to create profit from another’s capital.  This is in contrast to student finance.  In student finance, a student receives the service of education from the university after the Student Loans Company pays the university on the student’s behalf.  Thus, the beneficiary is the student in student finance.  In other words, the subject of labour in student finance is the student and the subject in Mudharabah must be the capital.

5)      Mudharabah is an equity investment whilst student finance is a debt contract

A student finance agreement initiates with a debt.  The moment a student agrees to a course; a sum of money is owed to the university.  Whereas, a Mudharbah never begins with a debt, rather, it initiates with equity and capital.
A student finance begins with money being owed.  A Mudharbah begins without any money being owed to any party.  Thus, the two are contractually different.

6)      The liability is on the assets in a Mudharabah

In a Mudharabah, the capital converts into assets constantly though buying and selling operations.  It is the assets which are the subject of liability.  If there is loss, it will be offset with the capital and assets of the Mudharabah.  The assets will be liquidated to pay the loss.  The entrepreneur only loses time and effort but nothing financial.
In student finance, a student must repay upon earning the defined threshold.  Thus, the liability is upon the student to repay the financed amount upon fulfilling the criteria.

7)      A student must earn and repay the capital plus interest

In student finance, the capital and interest must be earned and repaid by the entrepreneur.  In a Mudharabah, an entrepreneur does not earn the capital back to repay the capital provider.  An entrepreneur only shares the profits after securing the present capital.

8)      The profit sharing ratio must be known in a Mudharabah

The whole concept of Mudharabah is sharing of profits.  Mudharabah is partnership in profit sharing.  A partnership is not created until profits are realised.
In student finance, there is no pre-agreed profit sharing ratios.  Only conditional unilateral repayments are stated.

9)      Depletion and exhaustion of Mudharabah funds dissolves a Mudharabah

The majority of jurists if not all are in agreement that if the capital in a Mudharabah is exhausted, spent or depleted, then the Mudharabah automatically dissolves.  The Hanbali school clearly states that a Mudharabah no longer exists if the entrepreneur does not get access to the capital prior to the exhaustion of capital.[4]
In student finance, the tuition fees are spent and exhausted.  A student does not gain receipt of them.  If this is the capital of Mudharabah as argued in the fatwa in reference in the question, then this Mudharabah dissolves the moment the Student Loans Company pays the university as the capital has been spent elsewhere.
The fiqh and rationale behind this ruling is that the capital is what gives the investor a right to the profits.  Liquidity risk is what validates his profit.  If all of the capital is exhausted and spent prior to any work by the entrepreneur, then the capital provider is at loss and that was the risk he was exposed to.

10)  Previous capital does not justify future gain when capital lost

In a Mudharabah, a capital provider’s capital must remain throughout the Mudhrabah operation for profit-sharing to continue.  Profit sharing can only take place with the presence of risk by both parties.  When capital is lost and no longer present, the capital provider is not risking anything to reap the successive and future profits.  If he still claims a profit, that will be a clear sign of a loan as he is claiming due to the liability created upon the entrepreneur in lieu of past funding[5].

11)  The money earned above capital is profit in Mudharabah

In a Mudharabah, income above the capital threshold is considered profit.  Hence, if student finance is remotely considered to be a Mudharabah, the total tuition fees plus the maintenance loan is the capital.  If students typically borrow £27,000 for a three-year course, the capital would be in excess of £30,000 taking maintenance loans into consideration.  Whereas, the two repayment plans in student loans initiate repayment at thresholds of £17,495 or £21,000 per annum.  Therefore, if this is considered a Mudharabah as argued and repayments are considered profit sharing as voiced in the fatwa, why would repayment or ‘profit sharing’ initiate at thresholds lower than the capital provided?
If this was a Mudharabah, profits would only have been realised if the net asset value exceeds the capital.  Profit-sharing cannot take place if you do not possess the capital threshold.
In addition, merely earning £17,495 or £21,000 per annum does not mean a person has that amount; that is his gross pre-tax annual income.  Payments are deducted from one’s monthly salary of £1457 or £1750 a month.  Thus, there is no real link between the capital and repayment/sharing of profits as argued.

12)  25% liability in tuition fees

The terms and conditions in the student loans guide reads:
‘If you’re a full-time student, you’ll become liable for a percentage of your Tuition Fee Loan at the start of each term. If you’re a part-time student who normally lives in England you’ll be liable for the first instalment of your Tuition Fee Loan after you’ve been on your course for two weeks. You’ll become liable for future instalments at the start of the second and third terms of your course.’[6]
In Mudharabah, the capital is not guaranteed.  If a Mudharabah is dissolved, the entrepreneur must give back whatever capital is remaining and not the capital initially forwarded nor a percentage of it.  However, in student finance, a percentage is conditionally guaranteed and a repayment is conditionally due even if the student does not complete his course for whatever reason.
 
13)  The profits are co-owned in a Mudharabah

In a Mudharabah, the profits are co-owned.  This means that the capital provider and entrepreneur have co-ownership of a known percentage of what is in excess of the capital[7].
However, in student loans and tuition fees, whatever the student earns from his job, is not co-owned.  A student earns his wages and is owed by his employer.  The HMRC in collaboration with an employer, act as an agent to repay the Student Loans Company.  This is after a student authorises the agency of the HMRC when agreeing to student finance.  Thus, a student acquires ownership of the total wage through his physical possession and his agent’s constructive possession.  Thereafter, he makes a payment to the Student Loans Company.  The Student Loans Company do not own any of the wages earned; they are merely a beneficiary and have a claim which they exercise.
Thus, there is no partnership in profits.  Therefore, it is clear that the liability is on the student to repay which is a loan repayment in lieu of money given at an earlier date.
 
14)  Mudharabah is capital for business and not capital spending on a Mudharib

In a Mudharabah, the capital is for injecting in business and assets; the capital is not there to be spent on an entrepreneur.  The entrepreneur is never the direct subject of investment.  He does not spend on himself to give himself services.
In student finance, the capital is spent for the services and needs of the student.  The capital is not given for business.
 
15)  Tuition fees are depleted and lost in student finance

In student finance, the tuition fees are spent on the university fees.  If that is the capital for a supposed Mudharabah, there is not capital remaining as stated earlier.  Furthermore, the capital is an amanah (trust) in a Mudharabah.  That means that if the capital is lost without the negligence of the entrepreneur, he will not be liable or held responsible to pay the capital back and the Mudharabah will cease to exist.
The question arises, why is the student conditionally responsible to pay back the capital and share supposed profits? If this was a Mudharabah, he would not be responsible for this as the capital provider paid the university himself.
 
16)  Sharing of profits is necessary

In student loans, a percentage of earnings is repaid.  There is not a sharing agreement of acquired wealth.  It is not 50-50 or 60-40 but a percentage of earnings acquired.  This shows that the liability is solely upon the student and not on the assets.  There is no profit sharing, rather, a repayment of a claim.  Whereas in a Mudharabah, the capital provider does not have a liability nor claim on the entreprenuer, instead, he has a liability and claim on the assets and profits making it an equity investment.

17)  Profit sharing takes place after capital is secured in a Mudharabah

In a Mudharabah, profit is only shared after the capital has been secured and returned.  The excess is considered profit.  The entrepreneur first ensures there is sufficient money in the venture to pay back the capital.  Only after the capital is returned is there profit distribution[8].
In student finance, a student pays capital and interest simultaneously.  The amount and percentage of each is clearly defined.  That opposes the principles of Mudharabah as a Mudaharabah dictates payment of capital first.
 
18)  Mudharabah with a debt as capital is not permissible

The jurists clearly state that it is not permitted to use a debt owed by the entrepreneur to the capital provider as capital for the Mudharabah[9].  The AAOIFI standards state:
‘7/3: It is not permitted to use a debt owned by the mudarib or another party to the capital provider as capital in a Mudaraba contract.’
In student finance, the capital is lost and becomes a conditional debt.  If that is considered to be the capital for the supposed future Mudharabah, it is clearly not permissible as a debt is becoming the capital.  The student is expected to earn that back and the interest element and repay.

The Reality of Student Loans from a Fiqh Perspective

The student finance guide reads:
‘You have to register at your university or college before we can make your first payment. You’ll usually do this in the first week of your course and you may have to take along your Student Finance Entitlement letter. Your university or college will let us know you’ve registered and we’ll make your payment.’[10]
When a student registers for a course, the university are due a payment.  The student can either pay or opt for student finance.  If he selects student finance, the student finance will make the payment.
To ascertain the exact nature of the agreement, it is imperative to see the legal documentation.  Without analysing the legal documentation, it is difficult to ascertain the exact nature of the contract.  There are two possible Fiqh interpretations from the information available and studied.  The interpretations depend on whether the Student Loans Company is legally liable to pay the university or it merely acts on behalf of the student without any legal duty on them.

1)     If the university makes the Student Loans Company liable to pay and absolves the legal liability from the student, the scheme can be considered a Hawalah (debt transfer).
Hawalah is defined as a contract through which the liability for the settlement of a debt is transferred from a principal debtor (muheel) to a transferee (muhaal alaihi). When a valid hawalah is concluded, the debt is no longer demanded from the principal debtor. The three effects of a hawalah contract are the transfer of a debt and the liability for its payment from the principal debtor to the transferee, the release of the principal debtor from debt and liability, and the resulting right of the creditor to claim the debt from the transferee.

2)     If the university does not make the Student Loans Company liable but simply accepts the payment from the SLC, then this can be regarded as a Kafalah (financial guarantee).  This is further strengthened with the involvement of Student Finance Entitlement letter.

A Kafalah (Financial guarantee/guaranty) involves a situation in which a third party steps in to secure a debt owed by a person. As such, it represents a pledge given to a credit from a guarantor (kafeel) that the debtor (makfool) will discharge the debt or obligation to the satisfaction of the creditor. Once a valid kafalah is in effect, it establishes a right to the creditor to claim the debt either from the debtor or the guarantor.

And Allah Ta’ālā Alone Knows Best
Mufti Faraz Adam,
www.darulfiqh.com
 
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