Definition and Moral Obligation
Insolvency (Iflas): When the total due debts of a person exceed the total assets. Example: Assets AED 100,000; Debts AED 200,000. Person is insolvent.
Declaration of Insolvency (Taflees): A court order declaring a person insolvent and sequestering their assets. This is the formal legal step.
Moral Obligation Before Declaration: Even without a court declaration, a person who is technically insolvent (debts > assets) has a MORAL obligation to refrain from any action that harms creditors. This includes: not making donations, not providing loans, not giving preferential treatment to certain creditors, and not transferring assets.
Three Stages of Insolvency (the Insolvency standard)
Stage 1 — Creditor Demand: Creditors demand that the insolvent debtor pay pro-rata and refrain from donations, loans, preferential transfers. The debtor can seek assistance from authorities to enforce this.
Stage 2 — Creditor Restrictions: If the debtor refuses, creditors can file a claim and petition authorities to prevent: (a) donations; (b) loans; (c) preferential creditor treatment; (d) admissions of liability to relatives connected up to four vertical steps; (e) pre-paying debts not yet due; (f) transferring assets to certain creditors; (g) travel without a surety.
Stage 3 — Insolvency Declaration: The court declares insolvency upon: (a) creditor application showing debts exceed assets, OR (b) debtor self-application (unless court deems it fraudulent). The court has sole authority to declare.
Consequences of Insolvency Declaration (the Insolvency standard)
Consequence 1: Assets Are Sequestered All assets at the time of sequestration, plus future gifts, are attached to creditor claims. Assets remain in the debtor's name but cannot be disposed of without court approval.
Consequence 2: Post-Declaration Acts Are Void Any sale, gift, or endowment by the debtor AFTER declaration has no legal effect. Exceptions: acts relating to prior transactions (e.g., exercising a contract termination option).
Consequence 3: Future Debts Are Not Discharged New debts incurred after declaration attach to the debtor's future liability, NOT the sequestered assets. Those creditors cannot share in the sequestration.
Consequence 4: Undue Debts Accelerate All debts that were NOT yet due become immediately due. Creditors of undue debts can now share in the sequestered assets pro-rata with other creditors.
Consequence 5: Creditors Have No Legal Right Post-Distribution After assets are distributed, creditors have NO legal right to demand payment from the debtor for unpaid balances. HOWEVER, the debtor retains a MORAL obligation to pay in full if circumstances improve.
Special Case: Ijarah (Leasing) During Insolvency
If a lessee becomes insolvent during the lease term, the lessor: (a) is entitled to pro-rata share of rent for the period ALREADY enjoyed; and (b) can choose to either terminate the lease or continue it (in which case, rent for the remaining period is a creditor claim). The court may order continuation if it benefits other creditors.
Distribution of Insolvent Assets (the Insolvency standard)
Pro-Rata Distribution: All creditors share the available assets proportionally to their claims. There is NO priority order in Islamic law (unlike modern bankruptcy, which prioritizes employee claims, taxes, etc.). All unsecured creditors are equal. Secured creditors (those with mortgages or pledges) may have preferential claims depending on jurisdiction.
Revocation of Insolvency (the Insolvency standard)
If the debtor's circumstances improve and assets subsequently exceed debts, the court can revoke the insolvency declaration. The debtor regains full control of assets and can pursue personal transactions. There is no formal "discharge" in Islamic law — only revocation when circumstances change.