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Technical Meaning: The obligation which is the result of an offer given by one party and
the acceptance by the other party in a way where its legal effect is expressed on the
thing contracted upon.
Therefore, a valid Shariah contract is built upon three essential elements, which are
form of the contract, the subject matter of the contract, and the contracting parties.
The way by which an offer and acceptance can be made is not only confined to words
as it can be exercised also in other methods recognized by Shariah such as conduct,
written and gesture.
Generally, the formation of a lawful contract requires the fulfillment of two basic
conditions:
The general rule is deduced from Surah al-Nisa verse 29: O you who believe! Eat up
not your property among yourselves unjustly (batil) except it is a trade amongst you, by
mutual consent
1st part of the verse indicates the need for a lawful aim for the contract.
2nd part of the verse enjoins that every contract must be based on mutual consent.
Sighah
Sighah is the statement expressing the wills of contracting parties showing the purpose
of contract. The Islamic law emphasizes that contracts cannot exist unless someone
has made the offer and acceptance. Muslim jurists have some differences in defining
sighah:
(i) The Hanafis offer is made by the first party to the contract and it gives the
freedom of acceptance to the second party. Acceptance (qabul) statement
of acceptance by second party.
(ii) Majority jurists offer is made by those who want to transfer the ownership
and acceptance is made by those who want to take the possession.
Conditions of sighah:
The Shariah has laid down some essential conditions of the subject matter that need to
be fulfilled. They are the following:
(i) The existence of the subject matter at the time of the conclusion of the
contract (e.g. rendering medical services to a dead person or washing a
damaged car).
The subject matter must be precisely determined and clearly known to the
contracting parties to the extent that a later dispute can be avoided.
According to Shariah, the precise determination of the subject matter can
take place in its actuality through gesture or pointing out if it is in existence or
through viewing at the time of the contract or prior to it within the duration in
which it is not possible for the subject matter to change or through a
description that prevents from serious ignorance by way of giving a clear
description of its type and quantity.
The contract is not validly concluded if the contracting parties are not capable
of delivering the subject matter even though the subject matter exists at the
time the contract is concluded and is legally owned by the seller.
Jurists unanimously agree that the subject matter must fulfill the Shariah
rulings which in turn entails that it should be objects of intrinsic value and
items of considerable value for Muslims, have some use, legitimately
benefitting and can be possessed. This is because certain property may have
no economic value for Muslims but may carry some commercial benefits for
non-Muslims such as pork and wine. Thus, various kinds of services,
performances of an act, commodities, tangible and intangible assets like
intellectual property rights are also included, which can be transacted in a
financial contract. As the subject matter should also be a thing that can be
possessed, the sale of what has been made permissible for general people,
the sale of non-acquired things such as fishes in the river, and the sale of
public-owned properties such as public hospitals and buildings are not valid,.
This is because all these are not owned by any particular individual and they
do not even admit any individual ownership.
The contracting parties
They are the ones that exercise the sighah and conclude the contract. In order to
conclude the valid contract, the contracting parties must attain legal capacity
(dhimmah). The fitness of a person for the application of law to his action is called legal
capacity (ahliyyah). Ahliyyah is defined as the quality by which man becomes fit for what
he is entitled to what he is subjected to. Dhimmah or legal capacity is classified into 2
stages: capacity for inherent rights and obligation (ahliyyah al wujud) and capacity to
exercise right and discharge obligation (ahliyyah al ada)
3.3 Fundamental Principles of Shariah Law of Contract
(i) The Principle of Justice: Ensures that neither party to a contract may exploit
the other. Hence, riba is strictly prohibited.
(ii) The Principle of Transparency: Those concerned must share all available
information. Withholding crucial information which has bearing on the
transaction could render the contract invalid. Furthermore, contracts involving
a high degree of gharar are strictly prohibited. The objective is to prevent
transactions that lead to dispute and lack of trust.
(iii) The Principle of Maslaha: Means the common interest supported by the spirit
of Shariah and not by specific text. On the basis of Maslaha, a particular form
of transaction may be exempted from the general rule if it has been shown to
be in common practice to facilitate business.
Contracts can be recognized in several ways. They can be bilateral or unilateral, and
they can be express or implied.
A bilateral contract is a mutual exchange of promises between two parties. For example,
a loan agreement between you and the bank is a bilateral agreement.
A unilateral contract is one in which the offerer requests performance, rather than a
promise, from the person accepting the offer. A classic example is a reward
advertisement where money is offered in exchange for the return of a lost pet. The
person who returns the animal has satisfied the performance requirement; there was no
need for him to promise to return the animal.
An express contract is an agreement made in words, either in oral or written form. Here
are two examples of such contracts, one illustrating the oral form and the other, the
written.
(i) I offer to sell you my stamp collection, and after some negotiations you agree
to purchase it on the terms we have worked out, for RM 10,000. This is an
express oral contract.
(ii) Your landlord presents you with a pre-printed leaser on the apartment you
want. You agree to the terms and sign it. This is an express written contract.
An implied contract is formed by the behavior of the parties such that it clearly shows an
intent to enter into an agreement, even if no obvious offer or acceptance was clearly
stated in words or writing. Here is an example of an implied contract:
(i) You go into a convenience store, pick up a 1.5 liter bottle of Pepsi, take it to
the cashier, pay for it and walk out of the store without a word being said.
When a dispute arises over a contract between two parties, one party may accuse the
other of failing to perform under the terms of the agreement. Under the law, a partys
failure to fulfill his or her end of the bargain under a contract is known as breaching the
contract.
When a breach of contract happens (or when a breach is alleged), and informal
attempts at resolution fail, the party suffering the breach may wish to have the contract
enforced on its terms through a lawsuit and the court system, and try to recover any
financial harm caused by the breach. For example:
(i) You hire a contractor to lay copper pipes for your new kitchen sink. If, instead,
the contractor uses rust-prone iron pipes, you can recover the cost of
correcting the breach taking out the iron pipes and replacing them with
copper pipes.
(ii) Or the parties can agree to have a mediator review the dispute, which is
usually far less costly than sending the case to court.
3.6 Key Features of Islamic Finance Contracts
The Quran provides for a basic freedom to enter into contracts and transactions for
mutual benefits. The Arabic word for contract is aqd, which means to bind or to
strengthen. For a contract to be Shariah-compliant, it must have the following four
features, some of which are different from those of conventional contracts:
(ii) There is offer and acceptance by both parties on the purpose and terms of
the contract. An offer can be made by either seller or buyer. Similarly, the
acceptance can also come from either of them. So, if seller A offers to sell his
car for RM50, 000 and buyer B accepts it, this forms a valid contract.
Likewise, if buyer B states that he is ready to buy the car at RM 50, 000 and
seller A expresses his acceptance, this will constitute a contract. The offer and
acceptance can be written or verbal.
(iii) The purpose of the contract must not be haram (forbidden) or offensive to
Shariah. A conventional mortgage that charges the borrower 5 per cent
interest would be considered a haram contract because the practice of
lending money on interest is prohibited. A contract to buy and sell liquor would
also be haram.
(iv) The subject of the contract must change hands upon completion of the
contract. For example, if the contract is for the sale of a scooter by David to
Alice, ownership of the scooter must be transferred to Alice when the contract
period ends. Or if the scooter is leased to Alice, the possession of the scooter
must be transferred to Alice in order to achieve the purpose of the lease
contract.
(ii) The contracting parties must be aware of the exact quality, quantity and
specifications of the object of the contract in order to eliminate gharar
(uncertainty) that could lead to a dispute. This can be achieved by the
inspection of goods conducted by the buyer before entering into the contract,
or through detailed description if the inspection is not possible due to the
object being far away from the contracting place.
(iii) The contracting parties should be above 15 years of age and possess a
sound mind. This is meant to protect minors, insane persons and the
terminally ill, among others.
Although the above major ingredients may be found in all types of contracts, Islamic
jurists have taken great pains in examining every one of these contracts, and in defining
their nature as well as the parties involved in respect of their roles, right and
responsibilities. For example, a sales contract is different in nature from a car rental
agreement despite the inclusion of common contract elements, such as the presence of
two parties, offer and acceptance, and Shariah compliance. The subject of the rental
contract, the car, will continue to be the property of the owner whereas in the sales
contract, ownership of the car is transferred to the buyer.
There is no doubt that these contracting disputes, if adopted completely, can drastically
reduce the number of commercial disputes among people.
3.7 Commonly-Used Islamic Finance Contracts
(i) A wadiah savings account means that the deposit is for safekeeping only. The
bank is not obligated to offer you a return although it is allowed to provide
gifts, as long as those gifts are not officially required.
(iii) A qard hassan savings account provides no returns at all. This would be
equivalent to an interest-free loan in conventional finance.
Financing
Despite the variety of contracts that are available for financing, the very large majority of
contracts used BBA (or bai bithaman ajil), murabahah and ijarah, all of which are debt-
based.
(i) A BBA (cost plus profit margin) financing contract would be suitable if you
were to buy a house, and you need a long term mortgage loan which you
would like to repay by installments for the next 20 years.
(ii) A murabahah financing contract is similar to a BBA contract but for shorter
term needs. It would be suitable if, say, you have a retail toy business and
you need to purchase a container shipment of toys for the Christmas season,
but you need some financing to do so.
(iii) An ijarah financing contract is used for leasing assets for which ownership of
the asset is not taken. Leasing is like renting except that the duration of using
the asset is typically a few years, and the asset is usually large in value, such
as a car, a house or heavy machinery.
One reason why these three types of contracts form the very large majority of debt-
based financing contracts is that Islamic scholars are in general agreement about how
they should work. The other similarly-based contracts have less general agreement.
And compared to the equity-based financing contracts, BBA, murabahah and ijarah are
more popular because of their similarities to their conventional counterparts. Customers,
after all, like familiarity.
(i) In a mudharabah financing contract, the bank only provides capital to you for
a project based on a profit-sharing ratio. Note that unlike a mudharabah
savings account, where the bank puts the money to productive use, a
mudharabah financing contract is the exact opposite, where you are the
entrepreneur who puts the money financed to productive use. This sort of
financing requires the bank to do more due diligence on the nature of the
borrowers project.
(ii) In a musyarakah financing contract, the bank and you become joint-venture
partners. Both parties provide capital and decide on a profit-sharing
agreement. As in mudharabah financing, musyarakah financing requires the
bank to be very careful about whom it would choose as business partner.
Investing
Investing is encouraged in the Quran. For example, owning shares in a listed company
is a form of equity partnership, and such investing is encouraged with various halal
(permissible) and haram (forbidden) rules to be observed, of course.
Trade Financing
Whether you run your own business or work for a large international company, you will
have to deal with trade finance if you buy and sell internationally. Trade financing in the
Islamic context is mostly based on the contracts of murabahah and wakalah.
Unilateral contracts: These do not require the consent of the recipient and generally
favor the recipient with, for example, gifts, and free benevolent loans that require only
the return of principle.
Bilateral contracts: These are bound by specific rules based on agreement between the
two parties. As these contracts have a larger variety, there is no set way of categorizing
them.
Shariah contracts are divided into several classifications with regard to the purpose for
which certain contracts are entered into. These classifications are significant to
determine the rules and conditions which need to be met completely so as to make the
contracts valid and enforceable, and in turn all the legal effects of the contract will take
effect. Some types of contracts (despite their difference) share some common features,
purpose, and circumstances as well as legal consequence. Thus, they can be classified
under the same group. The classifications are as follows:
A. Contracts of exchange
B. Contracts of security
C. Contracts of partnership
D. Contracts of safe custody
E. Contracts pertaining to the utilization of usufruct
F. Other contracts
A) Contracts of Exchange
It involves an exchange between two parties. The contract is concluded in order to own
something in physical or benefit form through payment. Exchange-based contracts can
be divided into two main categories, namely sale-based contracts and lease-based
contracts. A few examples of this contract are sale and purchase, hire, money
exchange, bay al-inah, bay al-salam, ijarah and others. The list also includes all
subdivisions of contracts of sale and purchase normal or spot sale, mark-up sale
(murabahah), deferred payment sale (BBA), sale with advance payment but deferred
delivery (bay al-salam), sale of future delivery of goods with flexible payment of the
price or manufacturing contracts (bay al-istisna), sale of currency (al-sarf), etc. Some
controversial sales include sell and buy back (bay al-inah) and sale of debt (bay al-
dayn).
The legitimacy of a salam contract can be deduced from the Quran, the Sunnah of the
Prophet p.b.u.h. and legal consensus of Islamic scholars. Ibn Abbas mentioned about
the permissibility of a salam contract as one of debt based contracts. He also related
that when the Prophet p.b.u.h. migrated to Medina, the people were trading fruits for a
period of one, two or three years using the salam contract. Then he ordained: Whoever
pays money in advance (for fruit to be delivered later) should pay it for a known quality,
specified measure and weight (of dates or fruit) and along with the price and time of
delivery. Ibn Mundhir related the legal consensus of all scholars regarding the
permissibility of the salam contract, which is for the purpose of meeting the needs of
farmers who needed money for their agricultural productions, and feeding their family up
to harvesting time during which the agricultural products can be sold or delivered to the
buyer. It is for this reason that the salam contract has been exempted from the
prohibition of bay al-madum (selling of the non-existent).
The majority of scholars are of the opinion that there are three requirements of a salam
contract: transacting parties, subject matter and form (sighah) of a salam contract (offer
and acceptance). A salam contract is not valid unless its general and specific conditions
are completely met. General conditions refer to the conditions for a valid conclusion of
sale in general whereas specific conditions can be summarized as follows:
(i) The price must be clearly determined and paid in full by the buyer at the time of
undertaking the sale to avoid a later dispute.The seller on the other hand must
take possession of the price in full before departing one another. Otherwise it will
be tantamount to the sale of debt for a debt which is prohibited by the Prophet
p.b.u.h. and against the wisdom and purpose for which it has been made
permissible. If the price is a ribawi item, it is not allowed to be exchanged for
another ribawi item based on a salam contract to avoid riba al-fadl and riba al-
nasiah. Therefore, the exchange of weightable goods like wheat for aniother
weightable goods like barley cannot be done through a salam contract.
(ii) The second condition relates to the purchased commodity. A salam contract can
be effected on the commodities whose quality and quantity can be clearly
specified. This refers to commodities which can quantified in weights or through
measures. Therefore, the commodities whose quality or quantity is not
determined by specification cannot be sold through a salam contract.
(iii) The exact date and place of delivery must be specfied in the contract. Salam
cannot be effected for things which must be delivered on the spot. For example, if
wheat is bartered for barley, the simultaneous delivery of both is necessary for
the validity of sale. Therefore the contract of salam in this case is not allowed.
Literally, bay bithaman ajil (BBA) means a sale of deferred payment of price or simply
deferred payment sale.
Bay bithaman ajil is an Islamic financing product involving the sale of goods whereby
the sale price is payable on installment basis.
The bank will buy the asset first that is required by the customer from the owner of
asset. Subsequently, the asset belongs to the bank. After that the bank will sell back the
asset to the customer on deferred payment basis. This type of transaction is referred to
as deferred payment sale.
Under the conventional banking system, banks do not engage in the business of selling
goods, but rather grant loans repayable by monthly installments.
The word istisna is derived from the Arabic verb istasnaa which means to request
someone to manufacture an asset.
Bay al-istisna is defined as a contractual agreement with a manufacturer to produce
items with specified description at a determined price and manufactured from the
manufacturers own materials with his own effort.
According to jurists, the legality of istisna contract is established from different legal
sources such as the Sunnah, ijma, qiyas and istihsan.
There are no differences in opinion on its permissibility.
The Prophet p.b.u.h. is reported to have commissioned the manufacture of a ring
and a cupping glass.
If the subject matter does not conform to the contractual specifications at the time
of delivery, the purchaser has the right to either refuse or accept it.
Conditions of price
Price may be in the form of money and commodity.
May be spot and deferred
Can be paid in installments, may be tied up with different stages of projects.
Istisna - the manufacturer uses his own material
Ijarah - the material is provided by the customer and the manufacturer uses only
his labor and skills.
Table 4 illustrates the differences between salam and istisna in terms of assets,
payment, cancellation of order and time of delivery.
Bay al-Sarf is a contract of exchange of money for money. This contract is tightly
regulated under Shariah because it can be easily manipulated for the purpose of
producing an interest-bearing loan, which is prohibited in Islam.
Ibn Rushid examines the three forms of sale that can arise in a market where goods
and money are in existence:
when two commodities are exchanged, one may serve as a currency and the other as
a priced conmmodity, or both may be currencies. When a currency is exchanged for a
currency the sale is called sarf, and when a currency is exchanged for a priced
commodity, the transaction is a sale proper (bay). Similar is the sale of a priced
commodity for another priced commodity (barter)
The rules of bay al-sarf are derived largely from the well known hadith: Gold is to be
paid for by gold, silver by silver, wheat by wheat, barley by barley, dates by dates, and
salt by salt like for like, equal for equal, payment being made on the spot. If the
species differ, sell as you wish provided that payment is made on the spot.
Gold and silver were the currency of use at the time of the Prophet p.b.u.h. and he
approved their use by the act of using them himself. It cannot therefore be said that it is
wrong to use gold and silver as money. Many jurists have used analogy to argue that
the hadith on gold and silver represent all forms of monetary medium, and that therefore
all forms of currency should obey the rules established for gold and silver exchanges.
Therefore, most jurists agree that where an item is being used as money by custom
(urf) among a local population, it should obey the rules that are stated in the hadith
regarding gold and silver. Based on the above hadith, it is established that if gold is to
be exchanged for gold, the exchange must be made on the spot, with the amounts
being of equal quality and quantity. Because both countervalues must be settled
immediately, a forward transaction (in which one of the countervalues is delivered at a
future date) is not allowed. Given that exchanges must be equal for equal, a ten dollar
cannot be exchanged for nine one dollar notes. In addition, commissions on currency
exchange will be questioned by some scholars because of the contravention of the
equal for equal ruling.
Since trading currency involves ribawi items, it is always subject to the Islamic rules
enacted to govern such transactions so as to avoid the occurence of riba. Because of
this, scholars have come up with the following rules and condition of bay al-sarf:
(i) Delivery of both currencies must be done at the time of conclusion of the contract
to ensure that taking possession of the currencies exchanged by both transacting
parties can be completed in the same session (majlis).
(ii) If the currency trading involves the exchange of currencies of the same genus
such as silver for silver or gold for gold, they must be transacted in like-for-like
even if they differ in quality since consideration is given only to quantity.
(iii) The currency trading must be free from khiyar al-shart which refers to an option
to rescind a sale contract based on certain conditions stipulated earlier in the
contract. One of the contracting parties may stipulate certain conditions, which if
not met, would grant a legal right to the stipulating party an option to rescind the
contract. This is because khiyar al-shart prevents the actual establishment or
complete transfer of ownership which makes possession by any one party
impossible.
(iv) The last condition entails that the delivery of both counter-values should not be
deferred to a certain point of time in the future. If one of the parties stipulated a
deferment in the receipt of one of the currencies, the contract is rendered void
and null as it has been prescribed that exchange of goods eligible for riba should
be on a hand-to-hand basis.
B) Contracts of Security
This type of contract consists of three contracts which are kafalah, hiwalah and rahn.
Kafalah (surety)
Types of kafalah
Kafalah bi al-nafs
Guarantee to bring someone to a specific authority, such as the judiciary
Kafalah bi al-mal
Guarantee to return an asset to its owner
Can be divided into three main categories:
i. Kafalah bi al-dayn
Guarantee of repayment of another partys loan obligation
Elements of kafalah
1. Guarantor/surety (al-kafil)
A person who gives the guarantee is also called surety. A person who agrees to
be responsible for another persons liability especially paying for the persons
debt.
2. Creditor (al-makful lah)
A creditor to whom the guarantee is given
5. Sighah
Offer
Acceptance
Al-Rahn
The contract of al-Rahn does not require any financial obligation on the part of murtahin
(creditor) when the rahin (debtor) gives him the pawned object.
Elements of al-Rahn
a. Rahin
Pledgor a person who gives rahn/ the debtor
b. Murtahin
Pledgee a person who takes rahn/ the creditor
c. Marhun
Pledged asset a property to be pledged
d. Marhun Bih
The liability of rahn/the debt
e. Sighah
Ijab (offer)
Qabul (acceptance)
Pledge is intended to be a security for the payment of debt. It is not meant for
investment and profitable use. As such a pledgee is not allowed to exploit or use
the pledged property even with the permission of the pledger.
Table 2: Comparisons between Al Rahn and Conventional Pawning
Al-Hawalah
Al-hawalah means transferring a claim of a debt by shifting the responsibility from one
person to another. In other words, it is a transfer of debt from a debtor (transferor) to
another (transferee). Once the transferee has accepted the transfer of debt, the
transferor would be released from any obligation to pay the debt. The creditor can now
claim his debt only from the transferee. In Islamic banking operstions, this refers to a
transfer of funds/debt from the depositors/debtors account to the receivers/creditors
account whereby a commission may be charged for such services.
Categories of Al-Hawalah
i. Hawalah Muqayyadah
Restricted hawalah
restricted by a stipulation for the transferee to pay from property of the transferor,
owed to him by the transferee,or in the hand of the transferee.
this type of hawalah when a transfer is made with reference to the debt on the
transferee. The majority only recognizes this type of hiwalah.
Advantages of Al-Hawalah
i. Creditor
Could authenticate loan repayment and ensure that he/she (the creditor) could
retrieve his/ her money back by demanding payment from the transferor (muhal
alaih) under normal circumstances or even in case of default payment it could be
retrieved from the first debtor (transferee).
ii. Debtor
Minimize and spread his/her risk because he/she can remit or pass over his debt
to his own debtor.
Could convince the creditor to lend him money since he/she has somebody to
back him up as the transferor of the payment.
C) Contracts of Partnership
Musharakah
Musharakah is a contract of partnership between two or more parties in which all the
parties contribute capital, participate in the management, share the profit in proportion
to their capital or as per pre-agreed ratio and bear the losses (if any) in proportion to
their capital ratio.
In the Islamic banking operation, the Islamic bank may be a partner with its client for
running a business where both of them contribute capital, either both of them or the
client alone take part in the management of business as per terms of the contract and
share the profits at a pre-agreed ratio or bear the losses (if incurred), as per their capital
ratio.
Among the Sunnah provisions that support the legitimacy of partnership is the case of
al-Saib Ibn Abi al-Saib al-Makhzumi who was a partner of the Prophet p.b.u.h. in
business at the beginning of Islam. On the day of conquering Mecca when the Prophet
p.b.u.h. met Saib and addressed him Welcome my brother and partner.
Advantages of musharakah
Easy to establish
Risk transfer
Combination of skills
Best use of resources
Disadvantages of musharakah
Conflict decision making
Conflict of profits
Dependence of decision
Joint and several liabilities of partners
Mudarabah
Mudarabah is a partnership in profit whereby one party provides capital and the other
party provides skill and labor. The provider of capital is called rabbul mal, while the
provider of skill and labor is called mudarib. Hence we can define mudarabah as a
partnership contract between rabbul mal and mudarib in which the former provides
capital to the latter for investing it in a business enterprise by applying his skill, labor
and endeavor where both parties share the profits at a per pre-agreed ratio and the
losses (if any) being entirely borne by the rabbul mal except if it is incurred due to
breach of trust, for example, misconduct, negligence or violation of the conditions
agreed upon by the mudarib, then the mudarib becomes liable for that. This contract is
known as trustee profit sharing. It is a contract where the owner of capital entrust his
funds to an entrepreneur who contributes in business and the profits generated is to be
shared between them.The owner (fund provider) is the rabbul mal, while the person who
utilizes the fund (or fund manager) is the mudarib. The mudarib is exclusively
responsible for management of the business. Meanwhile, the rabbul mal does not have
any right to interfere in the business affair (refer to Figure 5).
Elements of mudarabah
Owners of capital
Entrepreneur
Capital
Business
Profit sharing
Contract (offer and Acceptance)
Figure 3: Mudarabah
In the context of Islamic banking operations, the Islamic bank can enter into a two-tier
mudarabah agreement, which may be explained as follows: (i) the first tier is an
agreement between the bank and the depositors, who agree to put their money into the
banks investment account and to share profits with it. In this case, the depositors are
the providers of the capital and the bank functions as the manager of funds; (ii) the
second tier is an agreement between the bank and the entrepreneurs who seek finance
from the bank on the condition that profits accruing from their business will be shared
between them and the bank in a previously mutually agreed proportion, but any losses
of the business will be borne by the financier only. In the above case, the bank
functions as the capital provider and the entrepreneur works as the manager. In case
there is more than one financier of the same project, that is, one project that is financed
by several banks, profits are to be shared in a mutually agreed proportion previously
determined, but losses are to be shared in the proportion in which the different
financiers have invested their capital.
1) Contracting parties
Mudarabah gives the right to the contracting parties to share the profit, while
liability for losses is borne by the participants.
2) Offer and Acceptance
Mudarabah has two pillars of offer and acceptance. Mudarabah is concluded when
the parties use words that clearly indicate the contract of mudarabah in their offer
and acceptance.
3) Capital
The capital in this partnership must be in absolute currency. It should be ready
cash and not in the form of debt.
4) Profit
Any profits made will be shared between the rabbul mal and mudarib according to
an agreed ratio, while losses are borne solely by the rabbul mal.
5) Work/Labor
The rabbul mal has no right to participate in the management of the business
which is carried out by the mudarib only.
Al-Wadiah
A contract where a person is entrusted to keep an asset for the benefit of an owner.
Acceptance of wadiah is a benevolent act, not for profit
Types of wadiah
Then, if he failed in any of the above , Wadiah Yad Amanah changes to Wadiah Yad
Dhamanah where he guarantees to return or replace the properties to the owners if they
were lost or destroyed.
Application Of Wadiah
Minimum opening : Minimum RM500 initial deposit for individual account and RM
1000 for non-individual account (Introducer required)
Age requirement : Open to all, aged 18 and above
Types of account :
Individual account
Joint Account
Partnership Account
Government Account
Association Account
Private Company Account
Contract: Wadiah
Ijarah (Leasing)
Ijarah refers to a lease or commission contract that involves an exchange of usufruct or
benefits of an asset or a service for rent or commission for an agreed period. In the
context of Islamic finance, the ijarah concept is usually applicable in financing contracts
such as in real property financing, vehicle financing, project financing and personal
financing. There are also financing products that enable customers to lease assets from
Islamic financial institutions with an option to acquire the leased assets at the end of the
lease tenure based on the concept of ijarah muntahia bi al-tamlik or al-ijarah thumma
al-bai (AITAB). These are alternatives to customers who prefer to buy a new car via
ijarah financing rather than taking up personal financing (bay al-inah).
The financing based on AITAB involves two types of contracts, namely leasing contract
(ijarah), followed by sale contract (al-bay)
At the initial stage, the Islamic financial institution will conclude an ijarah agreement with
the customer. Under this agreement, the Islamic financial institution will appoint the
customer as an agent to purchase the vehicle identified by the customer. Subsequently,
the Islamic financial institution will lease the vehicle to the customer for a specified
period.
Upon expiry of the lease period, the customer has the option to purchase the vehicle
from the Islamic financial institution. If the customer opts to purchase the vehicle, the
Islamic financial institution and the customer will conclude a sale contract and the
ownership of the vehicle will be transferred from the Islamic financial institution to the
customer.
i) The leased item should be transferred to the lessee on completion of the lease
agreement and should be of a condition that is fit for performance of the
required tasks. The lessor should transfer the leased items to the lessee in
their completed form.
ii) The products of the leased item should have value.
iii) The amount and timing of the lease payments should be agreed in advance,
though the agreed schedule and amount of those payments need not be
uniform.
iv) The lease payment schedule becomes active upon complete acquisition of the
usufruct of the leased goods, whether such usufruct is in fact enjoyed by the
lessor or not.
v) The period of the lease must be specified.
Three types of Ijarah arrangements can exist according to Shariah principles:
Ariyah (Lending)
Ariyah refers to a gratuitous loan of non-fungible objects, means the loan of a particular
piece of property, the substance of which is not consumed by being used without
anything taken in exchange.
ariyah is a contract in which one party loans another the use of some item for an
indefinite period of time, without fees. Ariyah is generally used to refer to the
neighborly lending of small articles.
Bay al-istijrar refers to an agreement between a client and a supplier, whereby the
supplier agrees to supply a particular product on an on-going basis, for example
monthly basis, at an agreed price and on the basis of an agreed mode of payment. It is
equally applicable for a contract between wholesaler and retailer for the supply of a
number of agreed assets.
Qard (Loan/Debt)
Wakalah (Agency)
Wakalah is a contract of agency in which one party appoints another party to perform a
certain task on his behalf, usually for payment of a fee or commission. An agency
arrangement without provision for payment of a fee cannot be considered irrevocable,
thus allowing an agent the right to terminate the agency at any time. This contract can
either be commutative or non-commutative. The bank may charge fees for providing
certain services to its customers; the bank can also pay a fee to perform an activity on
behalf of the bank by a customer, such as an agent (i.e., customer) to take delivery of
goods, or financial manager in investing the banks funds.
Contracts of an agent that are incumbent on his principal as in the following matters:
1. Hibah (gift)
2. Lending and borrowing
3. Debt (deferred payment sale)
4. Wadiah (safe custody)
5. Rahn (mortgage)
6. Musharakah, and
7. Mudharabah
In the contracts above, the agent must mention that he acts on behalf of his principal.
Jualah is an open promise by one party to pay whoever performs a particular task. This
contract is concluded unilaterally (compared to leasing). Some jurists linked it with
hiring, for example, the Malikis define it as a hiring contract for a benefit that is possible
to attain.
G) Gratuitous Contracts
A gratuitous contract is one, the object of which is for the benefit of the person for whom
it is made. It is a contract in which one party promises to do something without receiving
anything in exchange.
Therefore in such contracts only one person benefits.
The other party receives no profit or advantage or any advantage promised as a
consideration for his undertakings.
Gift is an example of a gratuitous contract.
wasiyyah (bequest)
Waqf (endowment)
Ibra (rebate/ waiving of debt)
Hibah
Rate will offer hibah as a consolation gift to the investor financial institution who
is willing to invest with the former.
Hibah is payable based on a certain percentage of the r rate of the investee
financial institution, subject to its affordability.
Application of hibah in the Contract of Ijarah Thumma Al-Bay
Qard contract is one of the contracts used to manage liquidity in Islamic finance.
The contract obliges a borrower to return the loan amount to the lender without
promising to pay any additional amount
However, in current practices, a borrower sometimes gives hibah to the lender at
his own discretion when paying off the debts.
Waqf (Endowment)
Waqf is an Arabic word derived from the root verb Waqafa. Awqaf is the plural of Waqf
or endowment which means to stop, to withhold and not to let go. Technically, it means
to allocate or to donate some property or cash for a specific purposes to receive the
pleasure of Allah and not to let it go through consumption or sale. The waqf property
comes into ownership of Allah and waqif will have no property rights on it. However,
waqif has the right to set the rules for the waqf item and manage the waqf.
Purposes of Waqf
(i) waqf ala al-aulad (general purpose)
refers to any form of charitable dedication or endowment made to support
all public welfare purposes without stating any special beneficiaries (be it
any individuals, organizations or institutions)
This type of charitable endowment can be used to support a diversity of
charitable work which can provide the benefits to the general public and
enhance the image of Islam and its community.
(ii) waqf ala al-aqarib (specific purpose)
Elements of waqf
Waqf founder
Waqf manager
Waqf document
Waqf beneficieries
Waqf Founder
Determines the type of management of his\her waqf. A waqf is a contract, therefore the
founder (called al-wqif or al-muabbis in Arabic) must be of the capacity to enter into a
contract. For this the founder must:
a) be an adult
b) be sound of mind
c) capable of handling financial affairs
d) not under interdiction for bankruptcy
Waqf Manager
a) is usually called Mutawalli, Nazir or Qayyim
b) his\her responsibility is to administer the waqf property to the best interest
of the beneficiaries and also to preserve the property
Waqf Document
Usually mentions how the mutawalli is compensated for thiseffort and if the document
does not mention a compensation for the mutawalli, he\she either volunteers the work
or seeks assignment of compensation from the court.
Waqf Beneficiaries
Can be persons and public utilities. The founder can specify which persons are eligible
for benefit (such the founder's family, entire community, only the poor, travelers). Public
utilities such as mosques, schools, bridges, graveyards and drinking fountains, can be
the beneficiaries of a waqf. Modern legislation divides the waqf as "charitable causes",
in which the beneficiaries are the public or the poor) and "family" waqf, in which the
founder makes the beneficiaries his relatives. There can also be multiple beneficiaries.
For example the founder may stipulate that half the proceeds go to his family, while the
other half go to the poor.Valid beneficiaries must satisfy the following conditions:
They must be identifiable. At least some of the beneficiaries must also exist at
the time of the founding of the waqf. The Mliks, however, hold that a waqf may
exist for some time without beneficiaries, whence the proceeds accumulate are
given to beneficiaries once they come into existence. An example of a non-
existent beneficiary is an unborn child.
The beneficiaries must not be at war with the Muslims. Scholars explain that non-
Muslim citizens of the Islamic state (dhimmi) can definitely be beneficiaries.
The beneficiaries may not use the waqf for a purpose in contradiction of Islamic
principles.
Termination of waqf
1) If the goods of the waqf are destroyed or damaged. Scholars interpret this as the
case where goods are no longer used in the manner intended by the founder.
The remains of the goods are to revert to the founder or his/her heirs. Other
scholars, however, hold that all possibilities must be examined to see if the goods
of the waqf can be used at all, exhausting all methods of exploitation before the
termination. Thus, land, according to such jurists, can never become
extinguished.
2) A waqf can be declared null and void by the , or religious judge, if its
formation includes committing acts otherwise illegal in Islam, or it does not satisfy
the conditions of validity, or if it is against the notion of philanthropy. Since waqf is
an Islamic institution it becomes void if the founder converts to another religion.
3) According to the Mlik school of thought, the termination of the waqf may be
specified in its founding declaration. As the waqf would expire whenever its
termination conditions are fulfilled (e.g. the last beneficiary). The waqf property
then returns to the founder, his/her heirs, or whoever is to receive it.
Ibra
In Islamic law, ibra means to free from responsibility. It is an act by a person to withdraw
his rights to collect payment from a person who has the obligation to repay the amount
borrowed from him. Ibra in a financing agreement is named the concept of giving a
rebate to a customer in case of early settlement. Rebate is not in the form of cash
payable to the customer, but will only be reflected as a reduction in the profit element of
the banks sale price.
Pillars Conditions
Contract (ijab & qabul) The contract is incorporated in the asset sale management. It
must be absolute and in definite and decisive language.
Guidelines on Ibra (Rebate) for Sale-Based Financing (2011)
Early Settlement Charges means costs incurred by the Bank due to early
settlement of the Facility before expiry of the tenure, whether in full or partially,
including but not limited to:
i. initial costs that have not been recovered by the Bank, and
ii. costs that have not been recovered because the financing contract has discount
elements at the initial period of financing.
Questions to Check Your Understanding of this Chapter:
1. What can you say about Conventional contracts when compared with Islamic
contracts?
3. The Islamic law excludes which two kinds of contracts from prohibition due to the
non- existence of the object at the time of the contract (e.g., illegal to sell a foetus)
3. When barter trading and currency exchange are concerned, the Islamic law
governing those transaction are concerned with two questions. What are the two
questions of concern?
4. Islam prohibits riba but permits trading. This indirectly means trading is free from riba.
What are the problems that can arise from trading activities?
5. Islamic commercial law consists of many different types of contract to suit different
needs and circumstances. True / False
References
Khir, K., Gupta, L. & Shanmugam, B. (2008). Islamic Banking. A Practical Perspective. Selangor: Pearson
Malaysia Sdn Bhd.
Bakar, M.D. (2008). Contracts in Islamic Commercial Law and their Application in Modern Islamic
Financial System. In Bakar, M.D. & Adawiyah, E.R. (Eds.), Essential Readings in Islamic Finance.
CERT Publications Sdn Bhd.
Ismail, A.G. (2010). Money, Islamic Banks and the Real Economy. Singapore: Cengage Learning Asia Pte
Ltd.
Islamic Financial System. Principles & Operations. (2011). International Shariah Research Academy for
Islamic Finance (ISRA).