PART III ISLAMIC FINANCE – PRODUCTS AND PROCEDURES 177 8 Overview of Financial Institutions and Products: Conventional and
M. Fahim Khan Division Chief
5.5 BROAD RULES FOR THE VALIDITY OF MU‘ ¯ AMAL ¯ AT
(Gbpwth) held the same view as that of ’Umar. Their interpretation implies that the vendor must be the real owner of the goods and, as such, the owner of their risk and reward. As regards the liability in case of damage, successors like Ta’aus and Qatadadh opined that if the goods were damaged before being paid for (in a cash sale), they belonged to the vendor.
But if they were damaged after the purchaser had promised to take them, they belonged to the latter and the former had to replace them. Further, according to Muhammad ibn Sirin, if any party in the contract makes a precondition for the replacement of damaged goods, the liability for such replacement is on the one who made it.17
Therefore, the subject matter of the sale must be in the possession (Qabza) of the seller at the time the sale is executed. In the case of Salam, certain conditions have been put in place to rule out the possibility of nondelivery of the goods in a normal business scenario.
For example, only those commodities that are normally available in the market at the time when delivery has to be made can become the subject of Salam, so that the Salam seller can get them from the market for delivery to the Salam buyer if he himself is unable to produce them as per the agreed specifications. In Istisna‘a, it becomes the responsibility of the manufacturer/seller to supply the specified asset at the agreed time.
Possession of the subject matter by the seller means that it must be in the physical or constructive possession of the seller when he sells it to another person. Constructive (Hukmi) possession means a situation where the possessor has not taken the physical delivery of the commodity, yet the commodity has come into his risk and control and all the rights and liabilities of the commodity are passed on to him, including the risk of its destruction. In the case of immovable assets, any legal notice of transfer or mutation is sufficient.
compensatory or commutative contracts. In noncompensatory contracts, like gifts, some uncertainty is affordable. Gharar conveys the meaning of uncertainty about the ultimate outcome of the contract, which may lead to dispute and litigation. Examples of transactions based on Gharar are the sale of fish in water, fruits of trees at the beginning of the season when their quality cannot be established or the future sale of not fully defined or specified products of a factory which is still under construction.18
In order to avoid uncertainty, valid sales require that the commodity being traded must exist at the time of sale; the seller should have acquired the ownership of that commodity and it must be in the physical or constructive possession of the seller. Salam or Salaf and Istisna‘a are the only two exceptions to this principle in Shar¯ı´ah and exemption has been granted by creating such conditions for their validity that Gharar is removed and there is little chance of dispute or exploitation of any of the parties. These conditions relate to the precise determination of quality, quantity, price and the time and place of delivery of the Salam goods.
Another relevant example of avoiding uncertainty is that of the sale of debt, which,per se, is not allowed even at the face value, because the subject matter or the amount of debt is not there and if the debtor defaults in payment, the debt purchaser will lose. Therefore, discounting of bills is not allowed as per Shar¯ı´ah rules. However, subjecting it to the rules of Hawalah (assignment of debt) will validate the transaction, because under the rules of Hawalah, the purchaser of debt (if it is on the face value) will have recourse to the original debtor and Gharar is removed.
Other examples of Gharar-based invalid transactions are short-selling of shares, the sale of conventional derivatives and the insurance business. Futures sales of shares, in which delivery of the shares is not given and taken and only a difference in price is adjusted, trading in shares of provisionally listed companies or speculation in shares and Forex business, in which only the difference is netted and delivery does not take place, are other examples of Gharar-based transactions.
However, speculationper se, which means sale/purchase keeping in mind possible change in prices in the future, is not prohibited. It is only such sales that may involve the sale of nonexistent and not owned goods/shares and Maisir/Qim¯ar that are prohibited.19
5.5.3 Avoiding Riba
As discussed in detail in previous chapters, Riba is an increase that has no corresponding consideration in an exchange of an asset for another asset. The increase without corresponding consideration could be either in exchange or loan transactions. As Islamic banks and financial institutions are involved in real sector trading activities as well as the creation of debt as a result of credit transactions, they must give special consideration to avoiding Riba lest their income might go to the Charity Account due to non-Shar¯ı´ah compliance. In the conventional sense, the cost of funds amounts to Riba and they have to make profit by way of pricing the goods or usufruct of assets and not by lending.
18Already discussed in detail in Chapter 3.
19Usmani, 1999, pp. 74, 75, 89–91.
5.5.4 Avoiding Qim¯ar and Maisir (Games of Chance)
Qim¯ar includes every form of gain or money, the acquisition of which depends purely on luck and chance. Maisir means getting something too easily or getting a profit without working for it. All contracts involving Qim¯ar and Maisir are prohibited. Present-day lotteries and prize schemes based purely on luck come under this prohibition. Dicing and wagering are rightly held to be within the definition of gambling and Maisir. Therefore, Islamic banks cannot launch any such schemes or products.20
5.5.5 Prohibition of Two Mutually Contingent Contracts
Two mutually contingent and inconsistent contracts have been prohibited by the holy Prophet (pbuh). This refers to
1. The sale of two articles in such a way that one who intends to purchase an article is obliged to purchase the other also at any given price.
2. The sale of a single article for two prices when one of the prices is not finally stipulated at the time of the execution of the sale.
3. Contingent sale.
4. Combining sale and lending in one contract.
In order to avoid this prohibition, jurists consider it preferable that a contract of sale must relate to only one transaction, and different contracts should not be mixed in such a way that the reward and liability of contracting parties involved in a transaction are not fully defined.
Therefore, rather than signing a single contract to cover more than one transaction, parties should enter into separate transactions under separate contracts.
Islamic banks may come across a number of transactions in which there could be inter- dependent agreements or stipulations that have to be avoided. The combination of some contracts is permissible subject to certain conditions:
• Bai‘ (sale) and Ijarah (leasing) are two contracts of totally different impacts; while ownership and risk are transferred to the buyer in Bai‘, neither ownership nor risk transfer from the lessor to the lessee. It is necessary, therefore, that lease and sale are kept as separate agreements. In Islamic banks’ Ijarah Muntahia-bi-Tamleek (lease culminating in transfer of ownership to the lessee), the relationship between the parties throughout the lease period remains that of the lessor and lessee and the bank remains liable for the risks and expenses relating to ownership. Transferring ownership risk to the lessee during the lease period would render the transaction void. However, one of the parties can undertake a unilateral promise to sell, buy or gift the asset at the termination of the lease period.
This will not be binding on the other party.
• Shirkah and Ijarah can be combined, meaning that a partner can give his part of ownership in an asset on lease to any co-partners. Jurists are unanimous about the permissibility of leasing one’s undivided share in a property to any other partner.21 However, sale of ownership units to the client in Diminishing Musharakah will have to be kept totally separate, requiring “offer and acceptance” for each unit.
20Already discussed in detail in Chapter 3. Also see Saleh, 1986.
21Usmani, 2000a, p. 86.
• Musharakah and Mudarabah can also be combined. For example, banks manage deposi- tors’ funds on the basis of Mudarabah; they can also deploy their funds in the business with the condition that the ratio of profit for a sleeping partner cannot be more than the ratio that their capital has in the total capital.
• Contracts of agency (Wakalah) and suretyship (Kafalah) can also be combined with sale or lease contracts, with the condition that the rights and liabilities arising from various contracts are taken as per their respective rules. As per present practice of Islamic banks, Wakalah is an important component of Murabaha, Salam and Istisna‘a agreements.
• Islamic banks can structure products by combining different modes subject to the fulfil- ment of their respective conditions. For example, they can combine Salam or Istisna‘a with Murabaha for preshipment export financing. Diminishing Musharakah is also a com- bination of Shirkah and Ijarah, added by an undertaking by one party to periodically sell/purchase the ownership to/from another partner.
Similarly, the exchange of two liabilities is prohibited. Transactions between two parties involve an exchange of any of the following types: corporeal property for corporeal property, corporeal property for a corresponding liability or a liability for another liability. Each one of these can be immediate for both parties or delayed for both or immediate for one party and delayed for the other. In this way, Ibn Rushd has identified nine kinds of sales.22 Out of the above categories of exchange, an exchange involving delay from both sides is not permitted as it amounts to the exchange of a debt for a debt, which is prohibited. That is why full prepayment is necessary for valid contracts of Salam. Some further details on “two deals in one transaction” are given in Chapter 6.
5.5.6 Conformity of Contracts with the Maqasid of Shar¯ı´ah
The injunctions of the Shar¯ı´ah are directed towards the realization of various objectives for the welfare of mankind. The objectives of the Shar¯ı´ah have been emphasized in a large number of the texts of the Qur’¯an and Sunnah. Any contract or transaction that militates against any of these objectives is invalid in Shar¯ı´ah. It is quite obvious that the rights of fellow beings have to be honoured in respect of all transactions. The rights of Allah (SWT) in Shar¯ı´ah also refer to everything that involves the benefit of the community at large. In this sense, they correspond with public rights in modern law. Therefore, any contract should not be against the benefits of the public at large.23
5.5.7 Profits with Liability
This principle states that a person is entitled to profit only when he bears the risk of loss in business. It operates in a number of contracts such as the contract of sale, hire or partnership.
Any excess over and above the principal sum paid to the creditor by the debtor is prohibited because the creditor does not bear any business risk with regard to the amount lent. In sale and lease agreements, parties have to bear risk as per the requirements of the respective contracts.
22Ibn Rushd, 1950, 2, p. 125.
23Mansoori, 2005, pp. 11, 12.
5.5.8 Permissibility as a General Rule
Everything that is not prohibited is permissible. The principle of permissibility establishes the fact that all agreements and conditions contained in them are permissible as long as they do not contradict any explicit text of the Qur’¯an or Sunnah.
Individuals are not always in a position to conduct exchange transactions on a spot payment basis. Many times, one of the two counter values to an exchange transaction is not exchanged simultaneously, as happens in credit (Mu’ajjal) or forward (Salam) transactions.
The validity of these transactions requires certain rules. Such contracts are discussed in detail in various other chapters.