This particular contract has become exceedingly popular in the Islamic banking context, as will be explored later.

A deferred payment sale contract is valid if the date of payment is set unambiguously. That means, the date can set with reference to a specific date (e.g., December 24) or a specific period (e.g., six months from the date of delivery of goods or services, or as otherwise agreed upon between the parties). However, the date of payment cannot be set with reference to a future event when the exact date of the occurrence of that event is either unknown or uncertain. If there is ambiguity in the date of payment, the sale is considered void.

Deferred Price Could Be More Than Spot Price

The deferred price could be set higher than the spot price – there is no restriction on that – as long as the price is set at the time of purchase. The price cannot be changed once the sale contract has been concluded. Even if the purchaser settles the account at a time earlier than that stipulated in the contract, the amount of payment must equal that agreed upon, and not be lower in consideration of earlier payment.

Dealing with Default

In an interest-based system, the seller would impose penalties (interest) on the buyer in case of a late payment. Such would not be permissible under Islam. However, the scholars agree that the seller may impose penalties for late payment in the form of mandatory charity (e.g., in the event of late payment, the buyer would pay $X per day to a specified charitable organization).

This must act solely as an incentive for the buyer to settle the account in a timely fashion. The seller must not benefit from the penalties paid by the buyer.

Other Penalties

If the sale is concluded with payment in installments, it is permissible for the seller to stipulate in the contract that if the buyer fails to make a payment, the whole amount will come due immediately.

It is also permissible for the seller to demand a security, either as a mortgage or a lien. The seller may also demand a promissory note or a bill of exchange.

Source: Usmani, Chapter 6

According to Mufti Taqi Usmani, a mudarabah arrangement differs from the musharakah in five major ways:

1. The investment in musharakah comes from all the partners, while in mudarabah, investment is the sole responsibility of rabb-ul-maal.
2. In musharakah, all the partners can participate in the management of the business and can work for it, while in mudarabah, the rabb-ul-maal has no right to participate in the management which is carried out by the mudarib only.
3. In musharakah all the partners share the loss to the extent of the ratio of their investment while in mudarabah the loss, if any, is suffered by the rabb-ul-mal only, because the mudarib does not invest anything. His loss is restricted to the fact that his labor has gone in vain and his work has not brought any fruit to him. However, this principle is subject to a condition that the mudarib has worked with due diligence which is normally required for the business of that type. If he has worked with negligence or has committed dishonesty, he shall be liable for the loss caused by his negligence or misconduct.
4. The liability of the partners in musharakah is normally unlimited. Therefore, if the liabilities of the business exceed its assets and the business goes in liquidation, all the exceeding liabilities shall be borne pro rata by all the partners. However, if all the partners have agreed that no partner shall incur any debt during the course of business, then the exceeding liabilities shall be borne by that partner alone who has incurred a debt on the business in violation of the aforesaid condition. Contrary to this is the case of mudarabah. Here the liability of rabb-ul-maal is limited to his investment, unless he has permitted the mudarib to incur debts on his behalf.
5. In musharakah, as soon as the partners mix up their capital in a joint pool, all the assets of the musharakah become jointly owned by all of them according to the proportion of their respective investment. Therefore, each one of them can benefit from the appreciation in the value of the assets, even if profit has not accrued through sales. The case of mudarabah is different. Here all the goods purchased by the mudarib are solely owned by the rabb-ul-maal, and the mudarib can earn his share in the profit only in case he sells the goods profitably. Therefore, he is not entitled to claim his share in the assets themselves, even if their value has increased.

Types of Mudarabah

1. The rabb-ul-maal may specify a business in which to invest, in which case the mudarib is restricted only to such business as pointed out by rabb-ul-maal. This is called restricted mudarabah or al-mudarabah al-muqayyadah.
2. If rabb-ul-maal has not specified a business in which to invest, it is considered an unrestricted mudarabah or al-mudarabah al-mutalaqah.

Distribution of Profit

The distribution of profit must be pre-determined by the two parties. Furthermore, the amount of profit ascribed to either of the parties must be independent of the capital amount, dependent solely on the actual profit realized by the commercial enterprise. That is, the profit assigned to a party cannot be a percentage of capital amount contributed as that would be considered a fixed return, or interest. The profit assigned to either of the parties cannot be a lumpsum amount either as this would also constitute interest.

As such, the only determination of profit distribution that is permissible is based on the actual profit earned by the enterprise.

The Shari'ah does not restrict or specify proportions to be distributed between the parties, leaving it to the best judgement of the two independent parties.

Termination of Mudarabah

The mudarabah contract can be terminated by either of the two parties at any time as long as a notice, per the contract terms, is given to the other party.

Furthermore, Hanafi and Hanbali jurists are of the opinion that a maximum term of the mudarabah contract can be set, whereafter the contract is terminated automatically. The Shafe'i and Maleki jurists are of the opinion that no term restriction can be added to the mudarabah contract. All jurists agree that one may not specify a minimum term of the mudarabah contract.

In a Musharakah, the party investing the capital shares equally in both the profit and loss, which is different from an interest-based system where the upside is limited while the downside is very nearly non-existent.

The Basic Rules of Musharakah

Since Musharakah is, in essence, a contract, all conditions and rules of a contract must be met. Apart from those, there are some basic rules that apply specifically to Musharakah.

Distribution of Profits

1. The proportion of profit to be distributed among the partners must be determined and agreed upon at the time of the contract. Otherwise the contract is not valid under Shari’ah.
2. According to Imam Malik and Imam Shafe’i, it is necessary that each partner’s share in the profit is exactly equal to the proportion of initial investment into the partnership.
3. According to Imam Ahmed, the ratio of profit distribution may vary, without restriction, from the ratio of investment.
4. According to Imam Abu Hanifah, the ratio of profit distribution may vary, however, for silent partners (non-active partners, who only contribute capital), it cannot be any higher than the ratio of investment.

Distribution of Loss

All the Muslim jurists are unanimous that each partner’s share in loss must be exactly equal to the ratio of initial investment. Anything to the contrary will render the contract invalid.

The Nature of Capital

There are the following opinions on this:

1. According to Imam Malik and some Hanbali jurists, the nature of capital is not a restriction in a Musharakah arrangement. Therefore, in-kind (non-cash) contributions by partners are allowed. The share in partnership will be determined based on the market value of the commodity contributed.
2. According to Imam Abu Hanifah and Imam Ahmed, no in-kind contributions are allowed in a Musharakah arrangement. This is because they believe it poses problems if the partnership needs to be liquidated or redistributed.
3. Imam Shafe’i makes a distinction between replaceable commodities and irreplaceable commodities (like cattle). The view is rather complex, and not important for our purposes.

For the purposes of modern business, the view of Imam Malik has been widely accepted.

Management of Musharakah

The norm is for each partner to take part in the management of the partnership, with each partner acting as an agent of the partnership and any work done by one partner deemed to be authorized by all partners. However, if the partners wish they can contract under alternate arrangements for the management of the partnership.

Termination of Musharakah

It is agreed upon by the jurists that a partnership is terminated if:

1. One of the partners terminates the partnership;
2. One of the partners dies (where the heirs get the choice to continue the partnership or liquidate it to draw their share from the partnership);
3. One of the partners becomes insane.

If the remaining partners want to continue the business under any of the above scenarios, it is achievable with mutual agreement. The remaining partners would have to purchase the share of the out-going partner.

Another question raised is whether the partners can agree, at the time of contracting, that the partnership will not be terminated unless all partners agree to the termination. Though the earlier fiqh books are silent on the issue, there is nothing in the Shari’ah that would prohibit such an arrangement.

Source: Usmani, Chapter 1.

Ar-Rahn is a permissible contract in Shari’ah. It is known from the Sunnah that when the Prophet of Allah, Muhammad (SAW), passed away, his shield was with a Jewish man in Medina as a collateral.

The conditions of Ar-Rahn

1. The indebted party cannot be coerced into putting up a collateral;
2. An orphan’s property cannot be put up as a collateral by the trustee, unless under exceptional circumstances;
3. The property held as collateral must be liquid;
4. The property held as collateral must be distinct from other properties;
5. The ownership does not change, therefore the owner is responsible for the cost of upkeeping the property even when it is pledged as a collateral. Likewise, the owner continues to enjoy any secondary benefits to the property;
6. There is disagreement among the scholars on whether the property pledged as a collateral can be used. Many of the scholars say that the property cannot be used by either the debtor or the borrower, while many argue that the owner (the borrower in this case) can continue to use the property;
7. If the property held as collateral is lost or damaged while in possession of the trustee, without any negligence on his part, there is no guarantee by the trustee;
8. The ownership of the property cannot be transferred until the debt is settled or the debtor allows for such a transaction;
9. If the borrower cannot pay back at the expiry of the term, the judge will order the property pledged as collateral to be sold in the open market, even if it is the residence of the borrower.

Sources: Abdelhaleem, 14-15 and Kharofa, 154-161.

1. The third party (“C”) will become indebted to the creditor (“A”) for the original debt under the same terms and conditions, as well as the amount, or the original debt between A and the original debtor (“B”).
2. A new debt will be created, whereby B will be indebted to C, for consideration similar in value to that of the original debt.

Al-Hewalah has been used by the Jewish scholars extensively to get around ribaa. The Muslim scholars, however, have clearly laid down the requirement for the original and the new debt to be of similar value. This difference between the Muslim scholars and the Jewish scholars stems from different core methodologies; the Muslim scholars emphasize the spirit of the law, whereas the Jewish scholars emphasize the letter of the law.

The Hewalah contract cannot take place unless all three parties agree to the arrangement.

Source: Abdelhaleem, 13. 

1. The specified payment in Jua’alah cannot be paid until the task is completed, whereas interim payments are accepted in an Ijarah arrangement. In a Jua’alah contract, payments in advance or interim payments are not legal.
2. Jua’alah has some gharar in it, which is approved by the Shari’ah, whereas an Ijarah contract has no gharar.
3. The Jua’alah contract is a permissible contract, which means it can be invalidated by either of the parties at any time, whereas an Ijarah contract is an obligatory contract which cannot be invalidated after being signed.
4. An Ijarah contract has a specified time-frame attached to it, whereas a Jua’alah contract has no time-frame (though a minority opinion among the Malikies argues that a time-frame is necessary).
5. The Jua’alah cannot be increased or decreased once the task has started.

Source: Abdelhaleem, 6.

According to a tradition in Al-Bukhari and Al-Muslim, the Prophet (SAW) approved of taking a sum as Jua’alah for blessing a sick person with the recitation of the Qur’an.

Source: Abdelhaleem, 6.

1. The property rented or leased must be in a useable condition (i.e., the lessee should be able to use the property for its intended purpose). Similarly, in a hire contract, the employee must be able to perform the job required of him or her.
2. Ijarah has to be for inconsumable goods.
3. The lessee or the employee is not permitted to use the subject in a manner contrary to what is permitted by the contract. Specifically, the lessee or the employee is not allowed to inflict any harm on the subject of the contract.
4. Ijarah contract cannot be made for a task that is a religious obligation. For example, it is prohibited to enter into an employment contract for leading the prayer of making the azaan. Ijarah is valid, however, for teaching the Qur’an or religious sciences, as well as secular subjects because these are not religious obligations.
5.  If the two parties disagree on the value of the reimbursement or the rent/lease on the property, after the contract commences, the word of the lessor/employer is accepted under oath upto the time of disagreement. At that point the contract is then invalidated.
6. The majority of the scholars say that the Ijarah contract does not end by the death of one of the two parties, as long as both parties can fulfill their end of the contract. The Hanafis, to the contrary, deem the contract invalidated with the death of one party.

Source: Abdelhaleem, 11-12.

There are two main types of subjects in an Ijarah contract:

1. Tasks, where the compensation is for effort expended of skill used (by an employee or a contractor), and
2. Property, where the compensation is for the use of a property (such as a car or a house).

An Ijarah contract cannot be cancelled unless both parties agree to it or if one of the parties fails to deliver.

The pillars of an Ijarah contract are:

1. Presence of two parties
2. Offer and acceptance
3. Reimbursement or compensation
4. Specified usage

Without any of the above the contract is not valid. A point to note here is the necessity to specify the reimbursement and the usage. If these are missing, the contract is valid only if the two parties agree on them later.

There are a number of conditions attached to an Ijarah contract that will be discussed next.

Sources:

Kharofa, 146-147
Abdelhaleem, 11

Like selling something halal for wine, pork, dead animal’s meat or idols in return.

Sale by a city-dweller to a desert-dweller

The Prophet prohibited the city-dwellers from purchasing from the desert-dwellers. In another narration, city-dwellers were prohibited from purchasing merchandise from merchants before they reach the market-place. Here, the city-dwellers are people who the knowledge of the price whereas the merchants traveling from other places and the deser-dwellers are ignorant of the prevailing market prices. Availability of information here gives an unfair advantage to one party, which is discouraged in Islam. This prohibition is fundamentally important in an era where those who lack information are commonly taken advantage of.

Sale of grapes to a wine-maker

Though this sale meets all the requirements of a contract (the object sold, grapes, is halal) the sale contract is discouraged by the Hanafi and the Shafe’i jurists while it has been considered invalid and nugatory by the Malekis and the Hanbalis. This shows that if the halal object being sold is to be used in a haram manner, the sale of that halal object becomes haram as well. This also applies to sale of weapons during times of sedition and similar examples.

Fraudulent Overbidding

This refers to the seller artificially increasing the price in an auction by conspiring with a bidder who does not intend to buy but bids just to raise the price.

Two contracts in one

It is prohibited to bring together in one contract two transactions like sale and commission, partnership and exchanging and marriage, agricultural partnership and trade-labour partnership.

Sale contract with alien condition

Though there are a number of opinions on this, the general opinion seems to be that having an unrelated condition in a sale contract is highly discouraged. One example of an unrelated condition is the seller prohibiting the buyer from on-selling the merchandise purchased.

Source: Kharofa, 83-90.

These sales were prohibited in the context of yet unborn offspring. This has wide-spread application in the present-day context.

Sale of things that cannot be delivered

These sales include fish in the sea and bird in the sky and are prohibited. Though the bird or the fish might eventually be caught and delivered on time, it is impossible to point to a specific or give ample description before the contract is accepted.

Sale involving ignorance or doubt

This typically refers to doubt with respect to the price, or consideration paid. An example of this is contracting to sell a commodity on “market price” where the term “market price” has not been defined in units of money.

Two sale proposals in one

This refers to proposing (first step of the contract) to sell one object at one of two different prices. For example, a proposal to sell a widget at $100 in cash or $150 six months hence is invalid even though the two proposals are valid on their own, independent of each other.

Sale of an impurity

Things considered unclean in Islam like wine, pork, meat of a dead animal and blood, to name a few.

Sale of water

Most jurists allow sale of water if it is from a privately owned source, though the Dhaheri scholars state the sale of water to be prohibited whether from a public or a private source (e.g., fountain or a well). One may, however, charge for the effort to retrieve or treat this water.

Sale of something before receiving the price

The Prophet said, narrated by Ahmad and Muslim from Jaber, “If you have bought foodstuff, do not sell it until you have received it in full.”

Sale of ‘inah

‘Inah or deferred-payment contract is a special arrangement whereby Party A sells an object to Party B for Price X to be paid at a later time and then purchases it back from Party B at Price Y in cash, where Y is lower than X. This effectively results in creating a ribaa like transaction. This sale is considered nugatory or invalid by all jurists, except a small minority among the Shafe’i and Dhaheri schools, who consider it makruh. Unfortunately, this type of sale contract is widely used in Islamic banking in Malaysia based on the minority opinion. We will discuss this is more detail later.

Source: Kharofa, 79-82.

If a person is coerced into contracting a sale, the contract is considered invalid. The Hanafi and Maliki scholars give room for the coerced party ’s belated consent once the force is removed. The Shafe’i and the Hanbali scholars consider the sale to be invalid. According to the Hanafi jurists, if a person is forced to sell his property without will, this will be considered an illegal act — meaning that not only is the contract not valid but the coercing party is punishable.

Sale by an insane person

By agreement among all scholars, a sale to an insane person is not valid. By analogy, a sale made to a drunken or a drugged person, or any person unable to reason at the time the sale is made, is also invalid. Interdiction due to illness making the person non compos mentis will fall under insanity as well.

Sale to a blind person

The Shafe’i scholars do not consider a sale to a blind person to be valid. The majority of the jurists, however, agree that if sufficient description of given to the blind person, the sale will be valid.

Sale by a child

A sale by a child (or to a child) is not valid if the child is not discerning or capable of reasoning. There is consensus of the scholars on this. However, when the child is discerning or capable or reasoning, most scholars allow the sale with the requirement of the guardian’s permission. The Shafe’is do not allow such a sale.

Sale of the which is not owned

A sale by a person who does not own the object of sale, and does not have the permission to sell from the owner, is not valid. This stems from the Prophet’s injunction, “Do not sell something which you do not own.” The Malikis and the Hanafis allow this sale if the owner gives a belated permission, after the fact.

Source: Kharofa, 77-79.

1. The contract should be concluded willingly and with mutual consent as per the Qur’anic injunction in Surah an-Nisaa 26.
2. Both parties to the contract must have the capacity to conduct such a sale. A sale by an insane person (temporarily or permanently insance), a child or a drunken person is not valid. Hanafis permit such a contract by a child as long as the guardians permit it. Hanbalis permit such a contract by a child as long as the child is mature enough to make a decision. The Hanbali position is based on verse 6 of Surah an-Nisaa.
3. The object of sale should carry a legal benefit to the buyer, usually in the form of property or service received.
4. The object of sale must be owned by the seller or the seller should have the owner’s express permission. In an agency situation if the owner gives a belated permission, after the sale has taken place, the contract is considered valid but without it the contract is void.
5. The seller must be capable of delivering the subject of the contract to the buyer, or the sale is nugatory. One cannot, therefore, sell something that is not in his or her possession (e.g., cannot sell a bird in the sky or fish in the water until possession has been taken).
6. The object of sale should be made known to the purchaser by sight or by ample description. If the object being sold is not seen by the purchaser and has not been sufficiently described, the sale is invalid. A major implication of this is the obligation on the seller to disclose any and all defects in the object of sale to the buyer for the sale to be valid. A strong opinion among the scholars is that the sale will be valid but the buyer will have the option to invalidate it upon inspecting the object bought.
7. The price, or consideration due, must be known to both parties. Therefore, a contract of ribaa where the price ultimately paid changes by the timing of the payment is not valid due to the uncertainty involved with respect to the price.

Source: Kharofa, 73-76.

An invalid contract, thus, would be one which is not sound in either its pillars or its characteristics, or both. According to the Hanafi scholars there is a this type, a corrupt contract, that is sound in its pillars but not in its characteristics. We will currently ignore the corrupt contract.

Kharofa divides the conditions as below:

Conditions of Confirmation (en’eqad)

• The existence of two contracting parties;
• The format and the subject; and
• Particular conditions for certain contracts to be valid (e.g., presence of two witnesses in a marriage contact without which the contract is nugatory).

Conditions of Execution (nafath)

• The contractor should be in possession of the subject, or at least should be able to hand it over if it is not in his possession; and
• There should be no claim from other parties to the subject of the contract.

Conditions of Obligation (lozum)

• The contract should not contain an element of choice or option; and
• The subject matter of the contract should be free from defects (that are not disclosed to the contacting party).

Conditions of Correctness (Sehah)

• The contract must have met each of the three pillars.

Source: Kharofa, Ala’ Eddin. Transactions in Islamic Law. 2nd ed. Kuala Lumpur: A.S. Noordeen, 2000. 28-30.

Source: Kharofa, Ala’ Eddin. Transactions in Islamic Law. 2nd ed. Kuala Lumpur: A.S. Noordeen, 2000. 22.

Kahrofa describes a promise as a verbal proposition made by one party to undertake something to the benefit of the other. Note the absence here of an explicit ijaab and qabool. Taqi Usmani further explains a promise as a one-sided commitment as opposed to a contract which typically requires two sides (with the exception of unilateral contracts that are rare in nature).

Kharofa explains that a contract has to be executed both from the legal and moral point-of-view, whereas a promise implies only a moral duty. Kharofa argues that fulfilling a promise is not an obligation (wajib), however, it is a noble quality. This view is particularly ascribed to Imam Abu Hanifah, Imam Shafi’e and Imam Ahmad.

Both Kharofa and Taqi Usmani point out that a promise is enforceable in the court under certain circumstances in accordance with the views held by Hasan al-Basri, Sa’id bin al-Ashwa, Imam Bukhari, Ibn al-’Arabi, al-Ghazali to name a few. This implies that a promise is legally enforceable.

Taqi Usmani argues that circumstances in the modern economy necessitate that a promise, for the purposes of Islamic commercial law, be considered binding.

We will not go into the details of the proofs provided for each of these positions as they are available on the Internet in Taqi Usmani’s book (referenced below). For our purposes what is important to understand is that promises are considered binding in Islamic commercial law by the majority of the contemporary scholars with the following conditions:

1. it should be a one-sided promise;
2. the promise must have caused the promisor to incur some liability;
3. If the promise is to purchase something, the actual sale must take place at the appointed time by the exchange of offer and acceptance. Mere promise itself should not be taken as the concluded sale; and
4. If the promisor backs out of his promise, the court may force him either to purchase the commodity or pay actual damages to the seller. The actual damages will include the actual monetary loss suffered by him, but will not include the opportunity cost.

Sources:
Kharofa, Ala’ Eddin. Transactions in Islamic Law. 2nd ed. Kuala Lumpur: A.S. Noordeen, 2000. 20-23.
Usmani, Taqi. Islamic Finance – Musharakah & Mudarabah. Karachi: Darul Uloom. Jamia Darul Uloom. 17 January 2006 [http://www.darululoomkhi.edu.pk/fiqh/islamicfinance/islamicfinance.html].

1. Unilateral; and
2. Bilateral.

A unilateral contract is gratuitous in character and does not require the consent of the recipient (qabool). Examples of a unilateral contract include gift (hadiah, hibah), off-set of the debt (ibra), will (wassiyyat) endowment (waqf) and loan (qard). Each of these transactions will be explained later in more detail.

A bilateral contract requires the consent of both parties and covers the remaining transactions in Islamic law. The scholars have traditionally divided bilateral contracts into six classifications:

1. Contracts of exchange (mu’awadat);
2. Contracts of security (tawthiqat);
3. Contracts of partnership (shirkah);
4. Contracts of safe custody (wadi’ah);
5. Contracts pertaining to the utilization of usufruct (manfa’ah); and
6. Contracts pertaining to do a work (e.g., wakalah and ju’alah).

These classifications and various contracts that come under these will form the basis of later discussion under contracts and transactions in Islamic law.

Source: “Contracts in Islamic Commercial and Their Application in Modern Islamic Financial System.” Iqtisad Al-Islamy. 2003. Islamic-World.Net. 16 January 2006. [http://islamic-world.net/economics/contract_01.htm].

1. Ijaab – the positive proposal; and
2. Qabool – the acceptance.

The coming together of ijaab and qabool makes up the contract.

There are three other conditions that Kharofa specifies for a contact to be legally acceptable and impactful.

1. the existence of two properly and aptly qualified contractors;
2. a format; and
3. a place of reference or subject matter.

Source: Kharofa, Ala’ Eddin. Transactions in Islamic Law. 2nd ed. Kuala Lumpur: A.S. Noordeen, 2000. 11-12.

Definition of Contract in Islam

According to Kharofa, the word ‘aqd (contract) in Arabic language means tying tightly, as in tying a rope. Arabs used the word to speak about firm belief or determination. They used to say ‘aqd al ‘ahd to mean ‘make a covenant’ and ‘aqd al yamin to mean ‘give an oath’. Along the same line is ‘adqat al nikah meaning a marriage contract.

The word ‘aqd also carries the meaning of obligations, as used in the first verse of Surah al-Maida. O ye who believe! Fulfil your obligations.

In Islamic jurisprudence the word contract is used to mean an engagement and agreement between two persons in a legally accepted, impactful and binding manner.

Definition of Contract in Man-Made Laws

The definition of a contract according to the French Civil Law in article 1101 is ‘an agreement which commits a person or a group of persons to give something, do something or refrain from something to another person or group of persons.’

The Distinction

The definition of a contract in both Islamic jurisprudence and the civil law are fairly similar. Kharofa states that the Islamic definition is stronger, however, I personally believe the difference is nothing more than artificial.

Source: Kharofa, Ala’ Eddin. Transactions in Islamic Law. 2nd ed. Kuala Lumpur: A.S. Noordeen, 2000. 1-7.