Category Archives: Contracts and Transactions

Bai’ Bithaman Ajil

A deferred payment sale where the payment is made in a single installment is called Bai' Bithaman Ajil. The deferred payment sale contract would include all the terms and conditions present in Bai' al-Mu'ajjal.

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

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Bai’ Mu’ajjal

Bai' Mu'ajjal is a deferred payment sale contract in which the parties agree to payment of the price at a time in future.

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

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Mudarabah

Mudarabah is a special kind of partnership where one partner providers the capital (rabb-ul-maal) to the other (mudarib) for investment in a commercial enterprise.

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.

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Musharakah

Musharakah is a type of Shirkat-ul-Amwal which literally means sharing. In the context of business, it refers to a joint enterprise in which partners (or parties) to the enterprise share the profit and loss of the enterprise. Musharakah has far reaching implications for Islamic banking and finance in the modern context and provides an excellent alternative to the interest-based economy.

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.

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Contract of Ar-Rahn – Definition and Conditions

Ar-Rahn, or mortgage or collateral, is defined in the Islamic jurisprudence as “possessions offered as security for a debt so that the debt will be taken from it in case the debtor failed to pay back the due money.”

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.

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Contract of Al-Hewalah

Al-Hewalah means to move. The term is typically used where the debtor moves his debt to a third party. For Al-Hewalah to take place, there are two necessary steps that must take place:

  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. 

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Difference Between a Jua’alah and an Ijarah

The primary differences between a Jua’alah and an Ijarah are below:

  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.

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