Islamic law of Contract

Essentials of Islamic Finance

IQRA University Gulshan Campus MBA Spring, 2016

Muhammad Yaseen
yaseenbiniqbal@gmail.com
Essentials of Islamic Finance IU Gulshan Campus, Slide # 1

Islamic law of
Contract

Essentials of Islamic Finance IU Gulshan Campus, Slide # 2

Contracts
It is compulsorily need for human being to the
mutual contracts & transactions to met there needs
& necessities, therefore we have found the contract
with its all types in pre Islamic era.
Financial contracts, like Trading, Leasing, and
Guarantee contracts, Mortgage, Marriage contract
etc were normally practiced.
Law of contract is the gateway to understand the
Islamic Economics & Riba free banking system
accordingly.
It is more important the understanding law of
contract for correct situation and authorization of
any transaction by Islamic jurisprudence.
Essentials of Islamic Finance IU Gulshan Campus, Slide # 3

Definition of Contract
Legally a contract is an agreement between two or
more persons or parties for doing something;
Therefore, exchange of goods, receiving a gift,
accepting a woman as wife through Nikah and
agreement on partnership etc. etc. come under the
umbrella of 'contract';
Contract has different types for which the rules
and law are different;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 4

Types of Contract
A contract can be of two nature:
Compensatory or financial contract;
This is a contract in which there is exchange of either goods or services
against an agreed compensation / price / fee / charges;

Non Compensatory or social contract;

This is a contract in which there is no exchange of either goods or services
against an agreed compensation / price / fee / charges;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 5

Types of Contract
CONTRACT

Compensatory / Financial Contract

Non Compensatory / Social Contract

Trade

Gift

Leasing

Nikah ?

Employment

Money lending

Partnership

Guarantee (Damanat)

Paid agency

Non-paid agency

Commission agency

Rights transfer (Hawalah)

Essentials of Islamic Finance IU Gulshan Campus, Slide # 6

Basics of Contract

A Financial Contract is allowed in Islam with some

conditions:
The contract should not contain any element of Riba
(explicit or implicit);
The contract should not have element of Gharar (excessive
uncertainty);
The contract should conform to the rules laid down by
Shari'ah for execution of contracts;
The contract should not be for those activities which have
been considered impermissible (Haram) i.e. general
prohibitions;
Element of Riba can easily be recognized and
eliminated;
Similarly compliance to the ruling about general
prohibition can also be achieved easily;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 7

Basics of Contract

Every contract has some basic elements which

should conform to rules of Shari'ah;
The elements of a contract are:
Parties/persons to contract (those who enter in a contract);
Wordings of contract;
Subject matter of contract (the thing/task meant by the
contract);
Compensation (remuneration/price for exchange);
Mechanics of the contracts (rights and responsibilities);

Essentials of Islamic Finance IU Gulshan Campus, Slide # 8

Basics of Contract
Contract

Parties

Wordings

Subject Matter

Compensation

Mechanics of contract

Essentials of Islamic Finance IU Gulshan Campus, Slide # 9

Basics Contract

Parties to contract should be:

Sane;
Mature enough to understand the nature of transaction;
Legally allowed for executing of such transaction
(licence/permit requirement etc. etc.);

Essentials of Islamic Finance IU Gulshan Campus, Slide # 10

Basics of Contract

Wordings of a contract should:

Contain Offer from one party and Acceptance from other
( Ijab-o-Qobool) in session of contract (Majlisul A'qd);
This Offer and Acceptance can be:
Oral/verbal

(Qauli), purchase through bargaining;

Implied/understanding (Ishsraa), purchase in super
market;

Be Present i.e. they must create sense of immediate effect

(words give sense of future are not allowed, I will buy it
does not make sense of immediate effect);
Unconditional and Non-contingent conditional wording do
not create immediate effects, I will accept if my father
allow it is a conditional wording;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 11

Basics of Contract

Subject matter of a contract should be:

Lawful legally and Islamically allowed;
The

transacted object must be legally owned by the parties

to a contract;

Existent something that exists,

Possession- constructive or physical
Deliverable can be transacted and exchanged, sale of fish
in water or bird in air;
Specified in clear manner for instance ;Toyota corolla, XLi,
engine # and chassis #;
Quantified if quantifiable, X1000 kg of wheat;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 12

Basics of Contract

Compensation (remuneration/price for exchange):

Conditions apply to Subject matter also apply here;
In case of barter system the application becomes
important;
Lawfulness, Existence, Deliverability, Specifiability and
Quantifiability become important;
In normal trade specification of currency is enough;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 13

Basics of Contract

Mechanics of the contracts (rights and responsibilities)

should be clear;

Both parties should bear the responsibility and have the

rights which are required by the nature of transaction;

In case of sale, ownership related risks should be born by

owner during the sale, after its transfer the owner is not
responsible.

Any condition inserted which is against the mechanics of the

contract is invalid, (making a lessee in a lease transaction
responsible for ownership related expenses is not allowed.
Guaranteeing of principle in a partnership is not allowed
whether both parties agree on it or not)
Essentials of Islamic Finance IU Gulshan Campus, Slide # 14

Conditional
Contract
Conditional contract are not permissible in Islam;

However, business norms allow conditional contracts

especially in current business scenario;

Ulema and scholars have described the method for

inserting a condition in a contract;

Three types of conditions are allowed while one type is not

allowed;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 15

Conditional
Contract
A condition, which is not against the basic objective of the contract,

is a valid condition, e.g. a condition of delivery to buyers premises;

A condition, which is against the basic objective of the contract, but

is in the market practice, is also a valid condition, e.g. condition of
five-year warranty and one year free service;

A condition, which is against the basic objective of the contract, not

in the market practice and not in favour of any contractor, is a valid
condition, e.g. a charity imposed on a transaction;

A condition that is against the basic objective of the contract and

not in market practice and favours one of the contractors or subject
matter or price, is a void and invalid condition, e.g. selling a car
with a condition from seller of its free use for two days every
month;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 16

Summary

A contract, whether it is a sale contract or Ijarah contract or

partnership contract, should conform to these basic rules;

Violation of these rules make the contract unacceptable to

Shari'ah;

As a matter of principle a contract in one sector may differ in

application of these rules from other contract in other sector;

Oil sector has different meaning for specification and

quantification from what sugar industry has;

Market norms of every sector are the decisive factors in this

regard;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 17

Sale

Here we will see its application to sale (being the vast

mode of financing in Islamic banking industry);
According to Islamic laws of sale these are key elements of
a sale transaction:
Contract of sale:
Wordings

i.e. Offer & Acceptance ( Ijab-o-Qobool) Oral/verbal

(Qauli) or Implied (Ishsraa);
Parties to contract (buyer and seller) [Mutaaquadain] must be
Sane and Mature;
Does not contain any unacceptable element i.e. sale must be noncontingent, immediate and unconditional;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 18

Basics of Sale
Subject Matter (sold good) [Mabee']:
Should

be Existing, Valuable and Usable, Capable of

ownership/title;
Deliverable, Specified and Quantified;
Seller should have title and risk.

Price:
Quantified

[Maloom]
Specified and certain [Mutaayyan];
Time and mode of payment should be well known;

Delivery and Possession of the sold goods:

Delivery

and possession either Physical/Actual or Constructive;

Place and method of delivery should also be known;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 19

Types of Sale

The application of the law of contract into Sale and

Purchase elaborates to us the way an Islamically
acceptable sale should be;

A sale sometimes does not comply with these laws and

misses some or one of the important elements;

In such case the sale is considered unacceptable to Islam;

There different levels in unacceptability to Shari'ah;

Coming slide elaborate these levels and types;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 20

Types of Sale

According to the nature of contract the sale has

four types:
Valid sale ( Bai Sahih):
A

sale that meets all requirements laid down by Shari'ah

for its contractual nature;

Void/ [Bai'-e-Baatil];
A

sale that does not meet basic requirements of its

contractual nature;

Valid sale but void due to defect (hung sale) [Bai'-e-Fasid];

A

sale that meets basic requirements of its contractual

nature but contains an impermissible element;

Valid but disliked sale (Bai Makrooh):

A

sale that meets basic requirements of its contractual

nature but executed in bad/unethical manners.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 21

Types of Sale

Valid Sale ( Bai'-e-Sahih):

A sale that meets all requirements laid down by Shari'ah for
its contractual nature;
A sale that executed by:
Eligible

parties;
With proper wordings;
For exchange of a permissible thing which is identified,
quantified and well known to both parties;
With specific price; and
Delivery of the sold goods

Exchange of a 'Citizen cx200 golden chain with black dial'

watch against cash payment of PKR 10,000/= with
immediate delivery is a Valid Sale transaction;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 22

Types of Sale

Void/[Bai'-e-Baatil];
A sale that does not meets some or all basic requirements
laid down by Shari'ah for its contractual nature;
A sale that executed:
By

ineligible parties; or
For exchange of a impermissible thing; or
For a thing which is not owned by seller; or
For a thing which is not deliverable;

Sale of stolen watch is an invalid (Baatil) sale.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 23

Types of Sale

Existing sale but void due to defect (hung sale)

[Bai'-e-Fasid];
A sale that meets basic requirements of its contractual
nature but contains an impermissible element;
A sale that executed:
With

element of Gharar;
For an unspecified thing; or
With unknown price;
Conditionally or contingently;
Sale of one Toyota corolla from a lot of cars with explaining
the specifications;

Such sale is a hung sale meaning the ownership transferred

if the buyer takes delivery but the status will be hung
unless the element is removed;
Essentials of Islamic Finance IU Gulshan Campus, Slide # 24

Types of Sale

Valid but disliked sale (Bai'-e-Makrooh):

A sale that meets basic requirements of its contractual
nature but executed in bad/unethical manners.
A

sale that executed at the time of Azaan for Jum'ah;

Sale of grapes to wine maker;
Sale of tranquilizer to addictive person;
Interruption in an ongoing deal between two;

Such sale is allowed but disliked by Shari'ah and

sometimes highly discouraged;

Essentials of Islamic Finance IU Gulshan Campus, Slide # 25

10 Rule of Sales

Essentials of Islamic Finance IU Gulshan Campus, Slide # 26

Rule of sale
Sale is defined in Shariah as
Exchange of a thing of value, by another thing of
value, with mutual consent

Essentials of Islamic Finance IU Gulshan Campus, Slide # 27

Rule of Sale
Rule 1

The subject of sale must exist at the time of sale.

For Example, A sells the unborn calf of his cow to
B, the sale is invalid.

Rule 2
The subject of sale must be in the ownership of seller at
the time of sale. Hence, what is not owned by the seller
cannot be sold.
For Example, A sells to B a car which is
presently owned by C. Since the car is not
owned by A at the time of sale, the sale is void.
Essentials of Islamic Finance IU Gulshan Campus, Slide # 28

Rule of Sale
Rule 3
The subject of sale must be in the physical or constructive
possession of seller at the time of sale.
Constructive Possession means where the buyer has
not taken physical delivery of goods, but the goods are
under his control. And all rights and liabilities of the
goods have passed to him,i.e. the goods are at his risk.
For Example, A has purchased a car from B, B has not
physically handed over the car to A but has placed it at
a garage which is in control of A. A can access the car
whenever he wants to do so. The risk of the car has
practically passed to A, the car is in the Constructive
Possession of A,now A can sell the car to third party.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 29

Rule of Sale
Rule 4

The sale must be instant and absolute. Thus a sale

attributed to a future date or a sale contingent on a
future event is void.
For Example, A says to B on the 1st of January: I sell
my car to you on the 1st of February. The sale is void,
because it is contingent on a future event.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 30

Rule of Sale
Rule 5
The subject of sale should be an object of value. A thing
having no value according to the usage of trade cannot be
sold.
Thus a thing having no value according to the usage of trade
e g; a leaf or a stone on a roadside cannot be sold or
purchased.

Rule 6
The subject of sale should not be a thing used for a Haram
purpose, e.g. pork, wine etc. The subject should be Maal-emutaqawwam

Essentials of Islamic Finance IU Gulshan Campus, Slide # 31

Rule of Sale
Rule 7
The subject of sale should be specifically known and
identified to the buyer. The subject of sale must be
identified by pointing out or by detailed specification
which can distinguish it from other things not sold.

For Example, A points to a building and says to B: I

sell one of the apartments in this building to you. The
sale is void unless the apartment is specifically
identified to the buyer.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 32

Rule of Sale
Rule 8
The delivery of the sold commodity to the buyer should
be certain and should not depend on a contingency or
chance.

For Example, A sells his stolen car to a person in hope

that he will manage to get it back, the sale is void.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 33

Rule of Sale
Rule 9
The certainty of price is a necessary condition for the
validity of sale.
For Example, A says to B: If you pay in one month, the
price is Rs50, but if you pay in 2 months the price is
Rs55. The price is uncertain and the sale is void.
A can give the two options to B, but then B must
select one option to validate the sale.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 34

Rule of Sale
Rule 10

The sale must be unconditional. A conditional sale is

invalid, unless the condition is recognized as a usual
practice of trade
For Example, A buys a refrigerator from B with a
condition that B undertakes its free service for 2
years. The condition, being recognized as a part of the
transaction, is valid and the sale is lawful.

Essentials of Islamic Finance IU Gulshan Campus, Slide # 35

Questions?

Essentials of Islamic Finance IU Gulshan Campus, Slide # 36