Liquidating Collateral to Settle an Outstanding Debt

Imām Gānim (d. 1030 AH) in Majmaʿ al-Ḍamānāt mentions that the creditor cannot liquidate the collateral except if he has one of the following:

1. Authorisation from the debtor
2. Approval from the court

The reason as to why the creditor cannot sell the item without permission is because he does not have Ḥaqq al-Taṣarruf(right of disposal). Ḥaqq al-Taṣarruffollows Ḥaqq al-Raqabah (proprietary title) by default, which the creditor does not have; he does not own the asset. The creditor and mortgagee (Murtahin) does not have Ḥaqq al-Raqabah, instead he only has Ḥaqq al-Yadd(possession), which has been authorised and ratified by the mortgagor. Ḥaqq al-Yadd(possession) comes when one party grants permission to another to hold and possess something they own. Due to this, the mortgagee must gain permission from someone who has Wilāyah (authority) to liquidate the asset. This can either be the owner of the collateral or a court.

The debtor’s permission to liquidate the collateral can be obtained through one of two methods:

1. Gaining authorisation upon default. However, this may not always be practical and possible.
2. Inserting a conditional agency (Wakālah Muʿallaqah) in the collateral agreement. In this scenario, both parties agree that if the debtor defaults, the creditor can act as an agent to liquidate the collateral and recoup the value. This arrangement is mentioned by Imam al-Marghīnānī (d. 593 AH). Imam al-Zaylaī (d. 743 AH) states that since the debtor is the rightful owner of the asset, they possess the authority to designate and delegate anyone they choose to liquidate the asset. Further, Wakālah is from the types of contracts known as Isqāṭāt; this refers to the idea that in such contracts, one party is forgoing their rights in favour of someone else to do and perform. In Wakālah, the principal is forgoing their rights and empowering the agent to act, hence it is a form of Isqāṭ.

The AAOIFI Standards also state that the mortgagee has the right to stipulate a condition that the mortgagor should appoint him or his representative as an agent who can sell the mortgaged asset and repay the debt out of its value in case of default, without resorting to judiciary. The mortgagor does not have the right to retreat from such agency once agreed upon. After repayment of the mortgagee’s debt the remaining value of the mortgaged asset should be given to the mortgagor by virtue of the mortgage contract. If the sale value of the mortgaged asset happened to be less than the due debt, the difference shall be subject to Shari’ah rulings on normal debt, and the mortgagee should have the right of recourse on the mortgagor for settlement of such difference. The mortgagee does not have the right to stipulate a condition that he should own the asset in case of default.

If a Wakālah to liquidate has been inserted within the contract, then the creditor retains the right to liquidate the collateral upon default. In the scenario mentioned above, where the collateral’s value surpasses the debt, following the sale of the collateral, the creditor is obliged to return the excess, as has been mentioned by Shaykh al-Islam Muftī Taqī Uthmānī quoting the classical jurists.

The rationale behind returning the excess amount has been mentioned by Imam al-Mawṣilī (d. 683 AH). He states that when a debtor pledges a collateral to the creditor, the creditor has received his debt legally (Ḥukman) according to the value of the collateral. This is Ḥukmanand not Ḥaqīqatan, as he has not actually liquidated the asset yet and received the funds, however, it is as good as having the outstanding debt in one’s ownership as the debt is secured and within touching distance of being realised. In cases where the collateral’s value exceeds the actual debt, the surplus is held by the creditor as an Amānah (trust) on behalf of the debtor. Therefore, it becomes the moral and legal obligation of the creditor to return this entrusted surplus to the debtor.

Imam al-Signāqī (d.711 AH) also mentions that the creditor’s rightful claim resides solely in the actual debt owed to him, not in the collateral. Hence, if the debtor defaults, the creditor retains his right to the debt owed, while the remaining amount is treated as an Amānah. These principles show how Sharīʿah recognises private property and upholds the rights of the property owner to this extent and degree.

While many collateral contracts typically incorporate the clause of Wakālah, it’s essential to note that if such a condition is not stipulated, and the debtor defaults, the creditor does not have the legal authority to liquidate the collateral. As Shaykh ul-Islam Muftī Taqī Uthmānī explains, in the absence of permission from the debtor to liquidate the collateral, the only remaining recourse is for the creditor to approach the debtor and request that they initiate the liquidation of the collateral. Subsequently, the debtor can then settle their debt with the creditor from the proceeds of the sale.