Navigating the hybrid world of insuring murabaha finance

Murabaha blurs the line between finance and trade, creating unique challenges for credit insurers. Understanding how TCI and TFI provisions apply is essential to managing cover.

When it comes to insuring commodity transactions, a distinction should be drawn between trade credit insurance (TCI) and trade finance insurance (TFI). Both protect against third-party default, but TCI covers the non-payment of trade debts by an insured buyer, with the seller of the commodities as the insured party. TFI, by contrast, typically concerns non-payment of a loan or other form of financing granted by a lender to a borrower to facilitate the borrower's trading activities, with the lender as the insured party.

In some instances, however, the line between financing trades and entering into them as principal can become blurred. A prominent example is murabaha financing, an area which has attracted considerable legal scrutiny in recent times.

Murabaha’s hybrid identity

Murabaha is a form of sharia-compliant financing, structured on a cost-plus-profit basis. The financier, typically at its customer’s request, purchases specific commodities from a third party at an agreed price and then immediately re-sells them to the customer at a pre-agreed profit margin.

For the murabaha contract to be valid, the financier must own the commodities before selling them on. This principle derives from a hadith:

‘Oh Hakeem, do not sell what you do not have.’

Thus, in murabaha financing, the financier does not simply advance funds to allow for the completion of the trade. Instead, they participate directly in the trade: briefly taking ownership in the commodities before selling them to the customer. The financier must therefore be comfortable with acquiring and passing ownership in the commodities.

A murabaha financier therefore acts both as financier and trader, a hybrid role that has implications from a credit insurance perspective.

Transfer of title: Why it matters

A TCI policy typically requires evidence of delivery of the underlying goods to establish the underlying insured debt.

A TFI policy would not ordinarily require evidence of delivery. In a murabaha structure, however, transfer of ownership becomes relevant, since the financed commodities must first be owned by the financier.

Murabaha financiers should review the documents they are acquiring to demonstrate their ownership (physical or constructive) of the goods they are financing. The specific delivery requirements in the policy should be reviewed and assessed against the insured’s business practices (for example, how bills of lading are handled and what shipping documents are required).

While proof of delivery may not be strictly necessary under a TFI, failure to demonstrate and evidence ownership in the underlying commodities may have implications for cover. In some cases, it may even constitute a material breach of the insured financing agreement (considered below).

Material breach of murabaha agreement

Many credit insurance policies contain an exclusion in circumstances where the insured acts in material breach of the underlying financing agreement.

The question of what constitutes ‘material’ is a question of fact, but the breach must be significant, not merely trivial or inconsequential.

For the reasons set out above, it can certainly be argued that ownership is a central and substantial feature of a murabaha facility, and that failure to demonstrate that the insured financier had ownership in the underlying commodities would therefore constitute a material breach of the murabaha financing agreement.

That said, failure to demonstrate ownership in the financed goods need not be fatal to a TCI/TFI claim. The issue was considered in the Australian case of Thera Agri Capital v BCC Trade Credit, which dealt with the insurance of a murabaha financing.

The claimant’s murabaha facility was insured pursuant to a TCI policy issued by the defendant insurer. However, many of the features of that policy were structured in a TFI manner. Notably, the insured goods were described as ‘financing the purchase’ of commodities, rather than the commodities themselves.

The claimant did not dispute the defendant insurer’s argument that the financing was not sharia-compliant. Because the underlying contracts were false, the insured could not in practice act as the seller, having no actual ownership of the commodities.

Nevertheless, the claimant was still successful in its claim. The Court held that the policy did not require strict compliance with the terms and sequencing of the finance documents in order to recover, particularly since the parties had acted in a manner contrary to the finance documents and disclosed this to insurers. The obligor’s failure to satisfy its payment obligations when due was sufficient to support the claim, and the Court found no material default from the insured.

This finding is highly fact-specific. It can be contrasted with other decisions we are aware of, in which insurers successfully argued that the debt must arise in accordance with the specific terms of the facility in order to be indemnifiable.

Due diligence in murabaha deals

Finally, the extent of an insured’s due diligence obligations may differ in a murabaha financing, particularly where the policy requires an insured to take steps to prevent or minimise loss.

In both TFI and TCI contexts, the insured needs to conduct due diligence on the creditworthiness of the obligor. In TCI, however, this responsibility typically extends further, requiring checks on the underlying trades themselves, including the reliability of suppliers, timing of shipment, and market value of pricing.

At the same time, under English law at least, exceptions based on negligence should be interpreted restrictively. To deny cover for breach of a due diligence clause, an insurer would usually need to show that the insured acted recklessly or with gross negligence, and that this failure was the proximate cause of the loss.

Accordingly, it is rare for a claim to be defeated based solely on a breach of the due diligence clause, but the insured should nevertheless be mindful of its obligations.

Managing murabaha’s hybrid nature

The hybrid features of a murabaha financing require specific consideration from a credit insurance perspective. In the absence of a bespoke cover for murabaha financing, there will be some uncertainty as to how certain provisions of TCI or TFI apply in a murabaha context.

This uncertainty has implications for both insurers and insureds, and the parties should factor this into their drafting and management of the policy.