1 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) O you who believe! Fulfill your obligations (Holy Quraan) Copyright Reserved 2010

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1 1 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) O you who believe! Fulfill your obligations (Holy Quraan)

2 2 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) INDEX Sr. Particulars Page 1 FIQH OF TRADE 3 2 MUDARABAH AND MUSHARAKH 7 3 Mudarabah Financing 8 4 Basic Tenets of a Mudarabah Contract 8 5 Types of Mudarabah 9 6 Termination of Mudarabah Contract 10 7 Musharakah Financing 10 8 Permanent Musharakah 11 9 Diminishing Musharakah Basic Tenets of a Musharakah Contract Distribution of Profit in Musharakah Sharing of Losses Termination of Musharakah Contract Benefits of Mudarabah/Musharakah on Society BA I SALAM AND ISTISNA Meaning of Salam Conditions of Salam Salam as a Mode of Financing ISTISNA Difference between Istisna and Salam Difference between Istisna and Ijarah Time of Delivery Istisna as a Mode of Financing 23

3 3 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) FIQH OF TRADE INTRODUCTION Most of the companions of the Holy Prophet (SAWS) were either traders or manufacturers. The Prophet Mohammed (SAWS) was himself engaged in this profession before he became a prophet. Trade, in Islamic jurisprudence, is the exchange of commodities based upon the mutual agreement of the two free, sane, adult owners who are capable of handing over what they are trading. Following are the some of the conditions that must be fulfilled for a valid transaction. Islamic Jurists and Fuqaha has set up some necessary conditions that must be fulfilled for a business transaction to be considered valid and binding in Islam. There are two types of conditions; some related to the participants in the sale while some are related to the goods being traded. The first three conditions are regarding the participants in the sale: 1. Mutual Agreement Both the buyer and the seller must willingly agree to all details of the transaction. Thus, someone being forced to buy or sell property invalidates the transaction. The Holy Qur an said Unless it be a trade with your mutual consent (Surah Al Nisa 4 Aayah 29) The Prophet Mohammed SAWS said "Verily business transactions are only (valid) by way of mutual agreement." (Ibn Maajah 2185)

4 4 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) 2. Both participants are allowed to engage in transactions Both the buyer and the seller must be people who are legitimately allowed to engage in business transactions. They must both be free (not slaves), adults (not children who have not reached puberty), sane, and rational. So the buying and selling of a child or a fool is invalid. But if the child caretaker gives permission, then it is valid according to the Hanafi School of thought. However being Muslim is not necessary for the validity of transaction, hence the buying and selling of a non-muslim is valid. (Badaye Al-Sanaye, Vol 4) 3. Ownership of property being traded Both parties in the transaction must own the property they are trading, due to the statement of the prophet. The Prophet said SAWS "Do not sell what you do not have." (Tirmithee, an- Nasaa'ee, and Ibn Maajah) However, a person may sell something on behalf of another with his permission. Similarly transaction of Fudhuli (Third party who does not own) depends on the permission of the owner. However, a person may take money from someone to go and buy property for him, as he is not selling anything himself in this case, he is merely a authorized representative. There are also some conditions that relate to the goods being traded: 1. Permissibility of the Goods That which is being sold must be something that is halaal (permissible) in its origin. He has only forbidden you: carrion, blood, the flesh of swine and that upon which a name other than 'Allah' has been invoked (Al-Baqarah, 173) The prophet (PBUH) said "Verily Allaah has prohibited the sale of Maytah, intoxicants, and idols." (Al-Bukhaaree 2236, Muslim 4024) The dead animal is known in English as 'carrion' or carcass. In Islamic terminology, it means an animal not slaughtered in accordance with the requirements of the Shariah. Thus the eatable parts of the dead animal are

5 5 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) forbidden while the bones of the dead animal and the hair, the feathers, hoof, which are not eatables, are clean and their use and buying and selling is permissible. Since the skin or hide of an animal carries impurities such as blood it is forbidden unless tanned. When tanned, it is permissible. The fat of the dead animal and everything made with it is forbidden. There is no way they can be used. Even buying and selling them are forbidden. The bone of pork and its hair is impure and their buying and selling is not permissible because pork is originally impure. Similarly buying and selling of human bone and hair is not permissible due to dignity and respect of human being. (Badaye Al-Sanaye 4) 2. Dispensability The goods must be things that can be handed over at the time of the sale. Thus, it is not permissible to sell a bird flying in the sky, even if it is expected that the bird will return (i.e. like a trained eagle). Similarly, it is not permissible to sell a fish in the sea, unless it is in an enclosed area that it cannot escape from. The point is that the buyer must be certain that he will be able to hand over the goods when the sale is made. 3. The Absence of Anonymity Both the goods and the price must be something clearly known to both participants in a sale. Selling an unknown or unspecified item, like "one of the sheep in the pen," or "one of the garments on display," without specifying the actual item, is a kind of gharar referred to in the previously mentioned prohibition. There are basically four kinds of transactions that are allowed in the Islamic Jurisprudence. Firstly, the exchange of item of value for another item of value is called Baiul Al-Muqayadha. Secondly the exchange of money for an item of value is called Al-Bai Al-Mutlaq. This is general type of transaction. Thirdly, exchange of debt for item of value is called Bai Al-Salam. Fourthly, exchange of money for money is called Bai Al-Sarf. The Bai Al-Sarf, the exchange of money for money, is permissible according to the basic principle of Hadith. The rules of bay al-sarf derive 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". (Muslim) The condition of the validity of this type of transaction is that both the buyer and seller must possess good and price before they separate without any option

6 6 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) of annulling the contract and defer payment. This transaction has three forms; gold for gold, silver for silver and one for other. The transaction of gold for gold or silver for silver is allowed only when they should be equal for equal and like for like and the payment would be made on the spot even one would be different in quality because any addition will invalidate the contract because it is the original form of Riba. Today currency of a country comes in this form of transaction and thus any addition in one side would be considered as Riba and thus not permissible. However, the transaction of one for another i.e. gold for silver and silver for silver, is permissible with differentiation in quantity because the species differ but possession must be on the spot from both side. The currencies of different countries can be exchange in unequal terms but possession must be at spot. The Scholars have opined that the currencies of different countries are of different species and the currencies of different countries can be exchange in unequal terms but possession must be at spot.

7 7 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) MUDARABAH AND MUSHARAKH INTRODUCTION The Financial markets and the financial industry are witnessing the growth of Islamic banking and finance. Although an Islamic banking and finance is a relatively new force in the world of banking but it surely is a force to reckon with. Especially after the recent financial doom which slumped markets worldwide and triggered the global financial crisis. Islamic financial institutions have demonstrated significant resilience and have been less affected compared to the conventional financial institutions because of the prohibitions on excessive leverage. The growth, in both size and in diversity in the Islamic finance industry has been especially robust over the past few years. It is today a USD 1 trillion industry and is growing at a phenomenal pace of 15 percent annually. Apart from its traditional strong hold in the Middle Eastern countries, it has spread its wings to Western countries as well. Islamic finance has a significant presence in Europe and England is touted to be the Islamic finance hub of the western world. Many leading and popular international banks have established Islamic banking units or windows to provide financial services and products that conform to Shariah. There are various modes of financing in Islamic finance and Mudarabah and Musharakah fall within this ambit. They are essential modes of financing and are very widely used by Islamic banking and financial institutions. It goes without saying that all the modes of financing adhere to Shariah principles. The 4 basic elements prohibited in Islamic mode of financing are Interest (Riba), Forbidden or impermissible goods (Haram), Gambling (Maysir) and ambiguity (Gharar).

8 8 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) Mudarabah Financing The term refers to a form of business contract in which one party brings capital and the other personal effort. The proportionate share in profit is determined by mutual agreement. But the loss, if any, is borne only by the owner of the capital, in which case the entrepreneur gets nothing for his labour. The financier is known as rab-al-maal and the entrepreneur as Mudarib. As a financing technique adopted by Islamic banks, it is a contract in which all the capital is provided by the Islamic bank while the business is managed by the other party. The profit is shared in pre-agreed ratios, and loss, if any, unless caused by negligence or violation of terms of the contract by the mudarib, is borne by the Islamic bank. The profits in a Mudarabah agreement may be shared in any proportion agreed between the parties beforehand. However, the loss is to be completely borne by the owner of the capital. In case of loss, the capital owner shall bear the monetary loss and entrepreneur shall loose the reward of his effort. Mudarabah could be individual effort or a joint one. Islamic banks practice Mudarabah in both its forms. In case of individual Mudarabah, an Islamic bank provides finance to a commercial venture, run by a person or a company on the basis of profit sharing. The joint Mudarabah may be between the investors and the bank on a continuing basis whereby the investors keep their funds in a special fund and share the profits. Many Islamic funds operate on the basis of joint Mudarabah. Basic Tenets of a Mudarabah Contract There are two contracting parties to a Mudarabah financing, i.e. the provider of funds (rab-al-maal) and the entrepreneur (Mudarib). The latter does not contribute any form of capital. Profit is shared between the capital provider and the entrepreneur according to a pre-determined profit-sharing ratio. The profit-sharing ratio has to be mutually consented upon and explicitly stated at the time of contracting (aqad or agreement) and has to be a proportion/percentage of profits. In principal any financial loss under Mudarabah financing must be borne by the Islamic banking institution. However, if the loss is caused by negligence, mis-management or breach of contracted terms by the customer, then the customer is liable for the loss.

9 9 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) Types of Mudarabah Mudarabah financing can be divided into two main types, i.e. Restricted Mudarabah (Mudarabah al muqayyadah) and Unrestricted Mudarabah (Mudarabah Mutlaqah). Under restricted Mudarabah, the Islamic banking institution may specify certain terms and conditions, for example stipulate a particular business or particular place for the customer to invest the capital. The customer is bound by all these restrictions and any violation of these restrictions may make the customer liable for the loss, if any. This type of Mudarabah financing may be used for contract financing of a specific project awarded to the customer. Under unrestricted Mudarabah, an Islamic banking institution does not impose any limitation on the customer/ partner, for example, on the type of business, place of business, methods of payment from the customers and period of investment. In this case, the Islamic banking institution will not have any recourse to the customer should the business incur losses due to the investment policy as there would have been no such policy prescribed by the Islamic banking institution in the first place. This type of Mudarabah, for example, may be used towards financing a customer s working capital requirements. The most important element of the Mudarabah contract is the distribution of profit. At the inception of the Mudarabah contract the contracting parties should agree on a definite proportion of the actual profit to which each of them is entitled. No particular proportion has been prescribed by the shariah; rather, it has been left to their mutual consent. They can share the profit in equal proportions, and they can also allocate different proportions for the rab-al-maal and the mudarib. However, they cannot allocate a lump sum amount of profit for any party, nor can they determine the share of any party at a specific rate tied up with the capital. To cite an example, let s say the rab-almal provides a capital of Rs 800,000. On this capital they cannot agree on a condition that Rs 60,000 out of the profit, if any, shall be the share of the mudarib, nor can they say that 15 percent or more of the capital shall be given to rab-al-maal. However, what can be agreed upon according to shariah is the profit-sharing ratio. Example, any profit arising out of the business, i.e. 40 percent of the actual profit shall go to the mudarib and 60 percent to the rab-al-maal or vice versa. It is also allowed that different proportions of profit are agreed in different situations. For example, the rab-al-maal may say to the mudarib at the beginning of the aqad that if you trade in gold, you will get 50 percent of the profit and if you trade in silver, you will get 33 percent of the profit, the profitsharing ratio can be anything in these circumstances as agreed upon by the contracting parties. Similarly there can be a case where the rab-al-maal can say to the mudarib that if he does business in his city or town, he can be entitled to

10 10 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) 30 percent of the profit, and if he does it in another town, his share can be 50 percent of the profit. It is important to cite, that apart from the agreed proportion of the profit, as determined in the above manner, the mudarib cannot claim any periodical salary or a fee or remuneration for the work done during the Mudarabah contract. On the other hand, if the business has incurred loss in some transactions and has gained profit in some others, the profit shall be used to offset the loss at the first instance then theremainder, if any, shall be distributed between the parties according to the agreed ratio. Termination of Mudarabah Contract The contract of the Mudarabah can be terminated at any time by either of the two parties. The only condition is to give a notice to the other party. If all assets are in cash form at the time of termination, and some profit has been earned on the principle amount, it shall be distributed between the parties according to the agreed ratio. However, if the assets are not in the cash form, the mudarib shall be given an opportunity to sell or liquidate them, so that the actual profit may be determined. There is a difference of opinion among the Muslim jurists about the question whether the contract of Mudarabah can be in effect for a specified period after which it terminates automatically. However, this difference of opinion relates only to the maximum time limit of the Mudharabah. On the question whether minimum time limit can be fixed by the parties before which Mudarabah cannot be terminated? No express answer to this question is found in the books of the Islamic Fiqh, but it appears from the general principles that no such limit can be fixed, and each party is at liberty to terminate the contract whenever he wishes. Therefore, if the parties agree, when entering into the Mudarabah, that no party shall terminate it during a specified period, except in specified circumstances it does not seem to violate any principle of Shariah, particularly in the light of the famous Hadeeth which says: All the conditions agreed upon by the Muslims are upheld, except a condition which allows what is prohibited or prohibits what is lawful. Musharakah Financing Musharakah is another popular technique of financing used by Islamic banks. It could roughly be translated as partnership. In this technique two or more financiers provide finance for a project. All partners are entitled to a share in the profits resulting from the project in a ratio which is mutually agreed upon. However, the losses, if any, are to be shared exactly in the proportion of capital proportion. All partners have a right to participate in the management of the

11 11 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) project. However, the partners also have a right to waive the right of participation in favour of any specific partner or person. This equity financing arrangement is widely regarded as the purest form of Islamic financing. There are two main forms of Musharakah: Permanent Musharakah and Diminishing Musharakah. Permanent Musharakah In this form of Musharakah an Islamic bank participates in the equity of a project and receives a share of profit on a pro-rata basis. The period of contract is not specified. So it can continue so long as the parties concerned wish it to continue. This technique is suitable for financing projects of a longer life where funds are committed over a long period and gestation period of the project may also be long. Diminishing Musharakah In this form of Musharakah equity participation and sharing of profit on a prorata basis is allowed. It also includes a method by which the bank keeps on reducing its equity in the project and ultimately transfers the ownership of the asset to the participants. The contract provides for a payment over and above the bank share in the profit for the equity of the project held by the bank. That is the bank gets a dividend on its equity. At the same time the entrepreneur purchases some of its equity. Thus, the equity held by the bank is progressively reduced. After a certain time the equity held by the bank shall come to zero and it shall cease to be a partner. Musharakah form of financing is being increasingly used the Islamic banks to finance domestic trade, imports and to issue letters of credit. It could also be applied in agriculture and industry. Basic Tenets of a Musharakah Contract Both parties contribute a portion of capital which may not necessarily be equal. The contributed capital can be either in the form of cash or assets with an ascribed value. While both partners may undertake the management of the business, if a partner chooses to withdraw from the management to become a sleeping partner, such arrangement is allowed. The partner is also allowed to appoint a third party to manage the business on behalf of the Musharakah partnership. The project or business must be permissible by shariah. The proportion of profit to be distributed between the partners must be mutually pre-agreed upon inception of the contract.

12 12 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) Any losses shall be distributed between the partners according to the capital contribution ratio. However, if the loss is due to the negligence of the managing partner or management team, such losses shall be borne by the respective partner or the management team. Distribution of Profit in Musharakah The distribution of profit is a very crucial issue in a Musharakah contract. The proportion of profit to be distributed between the partners must be agreed upon at the time of inception of the contract. If there s no mention of the proportion of profit then the contract is not valid according to shariah point of view. This is because the ratio of profit for each of the partner must be determined in proportion to the actual profit accrued to the business, and not in proportion to the capital invested by him. Also, it is not allowed to fix a lump sum amount for any one of the contracting partners, or any rate of profit tied up with his investment. Let us take an example to explain the distribution of profit in light of the Musharakah contract. Suppose, A and B enter in to a partnership and it is agreed between them that A shall be given Rs 20,000 per month as his share in the profit, and the remaining profit will go to B, this kind of partnership will be rejected by shariah. Similarly, if they agree between them that A will get 20 percent of his investment, the contract will still be pronounced as invalid by shariah. According to shariah, the correct basis for the distribution of profit would be an agreed percentage of the actual profit accrued to the business. If a lump sum amount or a certain percentage of the investment has been agreed for any of the partners, it must be expressly mentioned in the aqad (agreement) that it will be subject to the final settlement at the end of the term, meaning thereby that any amount so drawn by any partner shall be treated as on account payment and it will later on be adjusted to the actual profit he may deserve at the end of the term. But in case if no profit is actually earned or is less than anticipated, the amount drawn by the partner shall have to be returned. Sharing of Losses The sharing of losses is done in proportion to the investment made by each contracting partner in the venture. For example, if a partner has invested 30 percent of the capital, he must suffer 30 percent of the loss, not more, not less, and any condition to the contrary shall render the contract invalid. According to Muslim scholars the ratio of the share of a partner in profit-loss both must conform to the ratio of his investment. But some scholars differ on this profitloss ratio of investment. Some scholars assert that the ratio of the profit may differ from the ratio of investment according to the agreement of the partners, but the loss must be divided between them exactly in accordance with the ratio of capital invested by each one of them. It is this principle that has been

13 13 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) mentioned in the famous maxim: profit is based on the agreement of the parties, but loss is always subject to the ratio of investment. Termination of Musharakah Contract A Musharakah contract can be terminated in case of following events Very partner in the Musharakah contract has the right to terminate the contract at anytime, provided the partner gives his other partner/partners notice to this effect, upon which the contract will come to an end. In this case, if the assets of the Musharakah contract are in cash form, all of them will be distributed at pro-rata basis between the partners. But if the assets are not liquidated, then the partners to the contract may agree either on the liquidation of the assets, or on their distribution or partition between the partners, as the case may be. In case of dispute between the partners in the matter where one of the partner seeks liquidation while the other wants the partition or distribution of the non-liquid assets themselves, the latter shall be preferred, because after the termination of Musharakah, all the assets are in joint ownership of the partners, and a co-owner has a right to seek partition or separation, and no one can compel him on liquidation. However, if the assets are such that they cannot be separated or partitioned, i.e. Machinery, then they shall be sold and the sale proceeds shall be distributed. If any one of the partners dies during the contract, the contract of Musharakah with him stands terminated. His heirs in this case, will have the option either to draw the share of the deceased from the business, or to continue with the contract of the Musharakah. If any one of the partners becomes insane or otherwise becomes incapable of effecting commercial transactions, the Musharakah stands terminated. If one of the partners wants termination of the Musharakah, while the other partner or partners like to continue with the business, this purpose can be achieved by mutual agreement. In this case, the partners who want to run the business may purchase the share of the partner who wants to terminate his partnership, because the termination of the Musharakah with one partner does not imply its termination between other partners. Conclusion Financing through Mudarabah and Musharakah does never mean the advancing of money. In Mudarabah it means to participate in the business and in the case of Musharakah it means sharing in the assets of the business to the extent of the

14 14 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) ratio of financing. An investor/financier must share the loss incurred by the business to the extent of financing. The partners have the liberty to determine, with mutual consent, the ratio of profit allocated to each one of them, which may differ from the ratio of investment. However, in case a partner has expressly excluded himself from the responsibility of work for the business, he cannot claim more than the ratio of his investment in the project or business venture. In case of loss suffered in the project each partner must bear the loss exactly in the proportion of his investment. Benefits of Mudarabah/Musharakah Financing on Society Both Mudarabah/Musharakah financing are a part of the Islamic financial system which rejects the concept that a borrower is liable for the repayment of the funds borrowed and a predetermined return on those funds, regardless of the performance of the borrower s business. Under the Islamic system, this rejection of interest is replaced with the concept that the lender is to assume the risks of the borrower s business and share in the profits and losses of that business. Interest or riba at the outset is strictly prohibited in both Mudarabah/Musharakah or in any mode of Islamic financing. This is because interest as human suffering has shown over centuries, causes much harm to human beings. Its institutionalization, as in the secular/ western economies, causes wealth to be concentrated within the hands of the few, which is something Islam clearly forbids. Mudharabah/Musharakah financing are both based upon equity and profitsharing. This is due to the Islamic financial system which views equity capital, which is productive in a real sense and the social and economic relationships that have to be built, are not based on debt relationships, but upon equity and participation. Now this is a very different concept of society from that of the contemporary capitalist society, which is a society where human beings groan under the burden of debt, and the individual is seen as a consumer. Islam says it has to be a participating, a profitsharing society, based on a different model, and in this model, freedom can be ensured because every individual feels he is a participant in the drama of production and not in any way subject to a debt situation. Islam encourages Muslims to invest their money and to become partners in order to share profits and risks in the business instead of becoming creditors.

15 15 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) BA I SALAM AND ISTISNA It is one of the basic conditions for the validity of sale in Shariah that the commodity intended to be sold must be in the physical or constructive possession of the seller. This condition has three implications: First, the commodity must be existing a commodity that does not exist at the time of sale cannot be sold. Second, the seller should have acquired the ownership of that commodity. If the commodity exists but the seller does not own it, he cannot sell it to anybody. Third, mere ownership is not enough. It should have come in the possession of the seller, either physically or constructively. If the seller owns a commodity, but he has not acquired its delivery by himself or through an agent, he cannot sell it. There are only two exceptions to this general principle in Shariah. One is Salam and the other is Istisna. Both are sales of a special nature, and by the present article I want to explain the concept of these two kinds of sale and the extent to which they can be used for the purpose of financing. Meaning of Salam Salam is a sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange for an advanced price fully paid on the spot. Here the price is paid in cash, but the supply of the purchased goods is deferred. The buyer is called "rabb-us-salam", the seller is "Muslam ilaih", the cash price

16 16 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) is "ra's-ul-mal", and the purchased commodity is termed as "muslam fih", but for the purpose of simplicity, I shall use the English synonyms of these terms. The Holy Prophet, Sall-Allahu alayhi wa sallam, allowed Salam subject to certain conditions. The basic purpose of this sale was to meet the needs of the small farmers who needed money to grow their crops and to feed their family up to the time of their harvest. After the prohibition of riba they could not take usurious loans. Therefore, it was allowed for them to sell the agricultural products in advance. Similarly, the traders of Arabia used to export goods to other places and to import other goods to their homeland. They needed money to undertake this type of business. They could not borrow from the usurers after the prohibition of riba. It was, therefore, allowed for them that they sell the goods in advance. After receiving their cash price, they could easily undertake the aforesaid business. Salam was beneficial to the seller, because he received the price in advance, and it was beneficial to the buyer also, because normally, the price in Salam used to be lower than price in spot sales. The permissibility of Salam was an exception to the general rule that prohibits the forward sales. Therefore it was subjected to some strict conditions. These conditions are summarized below: Conditions of Salam 1. First of all, it is necessary for the validity of Salam that the buyer pays the price in full to the seller at the time of affecting the sale. It is necessary because in the absence of full payment by the buyer, it will be tantamount to a sale of debt against debt, which is expressly prohibited by the Holy Prophet, Sall-Allahu alayhi wa sallam. Moreover, the basic wisdom behind the permissibility of Salam is to fulfill the instant needs of the seller. If the price is not paid to him in full, the basic purpose of the transaction will be defeated. Therefore, all the Muslim jurists are unanimous on the point that the full payment of the price is necessary in Salam. However, Imam Malik is of the view that the seller may give a

17 17 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) concession of two or three days to the buyers, but this concession should not form part of their agreement. 2. Salam can be affected in those commodities only whose quality and quantity can be specified exactly. The things whose quality or quantity is not determined by the specification cannot be sold through the contract of Salam. For example, the precious stones cannot be sold on the basis of Salam, because every piece of precious stones is normally different from the other either in its quality or in its size or weight and their exact specification is not generally possible. 3. Salam cannot be affected on a particular commodity or on a product of a particular field or farm. For example, if the seller undertakes to supply wheat of a particular field, or the fruit of a particular tree, the Salam will not be valid, because there is a possibility that of that particular field or the fruit of that tree is destroyed before the delivery, and in the presence of this possibility the delivery remains uncertain. The same rule is applicable to every commodity whose supply is not certain. It is necessary that the quality of the commodity (intended to be purchased through Salam) be fully specified leaving no ambiguity that may lead to dispute. All the possible details in this respect must be expressly mentioned. 4. It is also necessary that the quantity of the commodity be agreed upon in unequivocal terms. If the commodity is quantified in weights according to the usage of its traders, its weight must be determined, and if it's quantified through measures, its exact measure should be known. What is normally weighed cannot be specified in measures and vice versa. 5. The exact date and place of delivery must be specified in the contract. 6. Salam cannot be affected in respect of those things that must be delivered at the spot. For example, if gold is purchased in exchange of silver, it is necessary, according to Shariah, that the delivery of both be simultaneous. Here, Salam cannot work. Similarly, 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.

18 18 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) All the Muslim jurists are unanimous on the principle that Salam will not be valid unless all these conditions are fully observed, because they are based on the express Ahadeeth of the Holy Prophet, Sall-Allahu alayhi wa sallam. The most famous hadith in this context is the one in which the Holy Prophet, Sall- Allahu alayhi wa sallam has said: "Whoever wishes to enter into a contract of Salam, he must effect the Salam according to the specified measure and the specified weight and the specified date of delivery." However, there are certain other conditions, which have been a point of difference between the different schools of the Islamic jurisprudence. Some of these conditions are discussed below: 1. It is necessary, according to the Hanafi school, that the commodity (for which Salam is effected) remains available in the market right from the day of contract up to the date of delivery. Therefore, if a commodity is not available in the market at the time of the contract, Salam cannot be effected in respect of that commodity, even though it is expected it will be available in the markets at the date of the delivery. However, all the other three schools of Fiqh (i.e. Shafi'i, Maliki, and Hanbali) are of the view that the availability of the commodity at the time of the contract is not a condition for the validity of Salam. What is necessary, according to them, is that it should be available at the time of delivery, only. This latter view can be acted upon in the present circumstances. 2. It is necessary, according to the Hanafi and Hanbali schools that the time of delivery is, at least, one month from the date of agreement. If the time of delivery is fixed earlier than one month, Salam is not valid. Their argument is that Salam has been allowed for the needs of small farmers and traders, therefore, they should be given enough opportunity to acquire the commodity, and they may not be able to supply the commodity before one month. Moreover, the price in Salam is normally lower than the price of spot sales. This concession in the price may be justified only when the commodities are delivered after a period that has a reasonable bearing on the prices. A period of less than one month does not normally affect the prices. Therefore, the minimum time of delivery should not be less than one month.

19 19 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) Imam Malik supports the view that there should be a minimum period for the contract of Salam. However, he is of the opinion that it should not be less than fifteen days, because the rates of the market may change within a fortnight. The view is, however, opposed by some other jurists, like Imam Shafi'i and some Hanafi jurists also. They say that the Holy Prophet Sall-Allahu alayhi wa sallam has not specified a minimum for the validity of Salam. The only condition, according to hadith, is that the time of delivery must be clearly defined. Therefore, no minimum period can be prescribed. The parties may fix any date for delivery with mutual consent. This view seems to be preferable in the present circumstances, because the Holy Prophet Sall-Allahu alayhi wa sallam has not prescribed a minimum period. The jurists have prescribed different periods that range between a day to one month. It is obvious that they have done so according to the expediency and keeping in view the interest of the poor sellers. But the expediency may differ from time to time and place to place. Likewise, sometimes it is more in the interest of the seller to fix an earlier date. As far as the price is concerned, it is not a necessary condition of Salam that the price is always lower than the market price on that day. The seller himself is the best judge of his interest, and if he accepts an earlier date of delivery with his free will and consent, there is no reason why he should be forbidden from doing so. Certain contemporary jurists have adopted this view considering it more suitable for the modern transactions. Salam as a Mode of Financing It is evident from the foregoing discussion that Shariah allowed Salam to fulfill the needs of farmers and traders, therefore, it is basically a mode of financing for small farmers and traders. The mode of financing can be used by modern banks and financial institution, especially to finance the agricultural sector. As pointed out earlier, the price in Salam may be fixed at a lower rate than the price of those commodities delivered at the spot. In this way, the difference between the two prices may be a valid profit for the banks or financial institutions. In order to ensure that the seller shall deliver the commodity on the agreed date,

20 20 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) they also can ask him to furnish a security, which may be in the form of a guarantee or in the form of mortgage or hypothecation. In case of default in delivery, the guarantor may be asked to deliver the same commodity by purchasing it from the market, or to recover the price advanced by him. The only problem in Salam that may agitate the modern banks and financial institutions today is that they will receive certain commodities from their clients, and will not receive money. Being conversant with dealing in money only, it seems to be cumbersome for them to receive different commodities from different client and to sell them in the market. They cannot sell those commodities before they are actually delivered to them, because it is prohibited in Shariah. But whenever we talk about the Islamic modes of financing, one basic point should never be ignored. The point is that the concept of the financial institutions dealing in money only is foreign to Islamic Shariah. If these institutions want to earn a halal profit, they shall have to deal in commodities in one way or the other, because no profit is allowed in Shariah on advancing loans only. Therefore, the establishment of an Islamic economy requires a basic change in the approach and in the outlook of the financial institutions. They shall have to establish a special cell for dealing in commodities. If such a special cell is established, it should not be difficult to purchase commodities through Salam and to sell in spot markets. However, there are two other ways of benefiting from the contract of Salam. First, after purchasing a commodity by way of Salam, the financial institutions may sell them through a parallel contract of Salam for the same date of delivery. The period of Salam in the second (parallel) transaction being shorter, the price may be a little higher than the price of the first transaction and the difference between the two prices shall be the profit earned by the institution. The shorter the period of Salam, the higher the price, and the greater the profit. In this way the institutions may manage their short term financing portfolios. Second, if a parallel contract of Salam is not feasible for one reason or another, they can enter into a promise to sell the commodity to a third party on the date of the delivery. Being merely a promise, and not the actual sale, their buyers will not have to pay the price in advance. Therefore, a higher price may be fixed

21 21 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) and as soon as the commodity is received by the institution, it will be sold to the third party on a pre-agreed price, according to the terms of the promise. A third option is sometimes proposed that at the date of the delivery, the commodity be sold back to the seller on a higher price. But this suggestion is not in line with the dictates of Shariah. It is never permitted by the Shariah that the purchased commodity be sold back to the seller before taking its delivery, and if it is done on a higher price it will tantamount to riba which is totally prohibited. Therefore, this proposal is not acceptable at all. ISTISNA Istisna is the second kind of sale where a commodity is transacted before it comes into existence. It means to order a manufacturer to manufacture a specific commodity for the purchaser. If the manufacture undertakes to manufacture the goods for him, the transaction of Istisna comes into existence. But it is necessary for the validity of Istisna that the price is fixed with the consent of the parties and that necessary specification of the commodity (intended to be manufactured) is fully settled between them. The contract of Istisna creates a moral obligation on the manufacturer to manufacture the goods, but before he starts the work, any one of the parties may cancel the contract after giving a notice to the other. But after the manufacturer has started the work, the contract cannot be cancelled unilaterally. Difference between Istisna and Salam Keeping in view this nature of Istisna there are several points of difference between Istisna and Salam which are summarized below: The subject of Istisna is always a thing that needs manufacturing, while Salam can be affected on anything, no matter whether it needs manufacturing or not. It is necessary for Salam that the price is paid in advance, while it is not necessary in Istisna.

22 22 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) The contract of Salam, once affected, cannot be cancelled unilaterally, while the contract of Istisna can be cancelled before the manufacturer starts the work. The time of delivery is an essential part of the sale in Salam while it is not necessary in Istisna that the time of the delivery is fixed. Difference between Istisna and Ijarah It should also be kept in mind that the manufacturer, in Istisna, undertakes to make the required goods with his own material. Therefore, this transaction implies that the manufacturer shall obtain the material, if it is not already with him, and shall undertake the work required for making the ordered goods with it. If the customer provides the material, and the manufacturer is required to use his labor and skill only, the transaction is not Istisna. In this case it will be a transaction of Ijarah whereby the services of a person are retained for a specified fee paid to him. When the seller has manufactured the required goods, he should present them to the purchaser. But there is a difference of opinion among the Muslim jurists whether or not the purchaser has a right to reject the goods at this stage. Imam Abu Hanifah is of the view that he can exercise his "option of seeing" (Khiyarur-ru'yah) after seeing the goods, because Istisna is a sale and if somebody purchases a thing which is not seen by him, he has the option to cancel the sale after seeing it. The same principle is applicable to Istisna. However, Imam Abu Yousuf says that if the commodity conforms to the specification agreed upon between the parties at the time of the contract, the purchaser is bound to accept the goods and he cannot exercise the option of seeing. This view has been preferred by the jurists of the Ottoman Empire, and the Hanafi law has been codified according to this view, because it is damaging in the context of modern trade and industry, that the manufacturer exerts all his resources to prepare the required goods, and the purchaser cancels the sale without assigning any reason, even though the goods are in full conformity with the required specifications.

23 23 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) Time of Delivery As pointed out earlier, it is not necessary in Istisna that the time of delivery is fixed. However, the purchaser may fix a maximum time for delivery that means that if the manufacturer delays the delivery after the appointed time, he will not be bound to accept the goods and pay the price. In order to ensure that the goods will be delivered within the specified period, some modern agreements of this nature contain a penal clause to the effect that in case the manufacturer delays the delivery after the appointed time, he shall be liable to a penalty which shall be calculated on a daily basis. Can such a penal clause be inserted in a contract of Istisna according to Shariah? Although the classical jurists seem to be silent about this question while they discuss the contract of Istisna, yet they have allowed a similar condition in the case of Ijarah. They say, if a person hires the service of a tailor to tailor his clothes, the fee may be variable according to the time of delivery. The hirer may say that he will pay Rs. 100/- in case the tailor prepares the clothes within one day and Rs. 80/- in case he prepares it after two days. On the same analogy, the price in Istisna may be tied with the time of delivery, and it will be permissible if it is agreed between the parties that in case of delay in delivery, the price shall be reduced by a specified amount per day. Istisna as a Mode of Financing Istisna can be used for providing the facility of financing in certain transactions, especially in the sector of house financing. If the client has his own land and he seeks financing for the construction of a house, the financier may undertake to construct the house on that open land, on the basis of Istisna, and if the client has no land and he wants to purchase the land also, the financier may undertake to provide him a constructed house on the specified piece of land. Since it is not necessary in Istisna that the price is paid in advance, nor is it necessary that it is paid at the time of the delivery, rather, it may be deferred to any time according to the agreement of the parties, therefore, the time of

24 24 ISLAMIC LAW OF TRADE (Fiqh-Al-Muamlaat) payment may be fixed in whatever manner they wish. The payment may also be in installments. On the other hand, it is not necessary that the financier himself construct the house. He can enter into a parallel contract of Istisna with a third party, or may hire the services of a contractor (other than the client). In both cases, he can calculate his cost and fix the price of Istisna with his client in a manner that may give him a reasonable profit over his cost. The payment of installments by the client may start, in this case, right from the day when the contract of Istisna is signed by the parties, and may continue during the construction of the house and after it is handed over to the client. In order to secure the payments of installments, the financier as a security may keep the title deeds of the house or land, or any other property, until the client pays the last installment. The financier, in this case, will be responsible for the construction of the house in full conformity with the specifications detailed in the agreement. In case of discrepancy, the financier will undertake such alternation on his own cost as may be necessary for bringing it in harmony with the terms of the contract. The instrument of Istisna may also be used for project financing on similar lines. If a client wants to install a machinery plant in his factory, and the plant needs to be manufactured, the financier may undertake to prepare the plant through the contract of Istisna according to the aforesaid procedure. The same principles will be fully applicable to the construction of a building for the industry. (Courtesy: Mufti Mohammad Taqi Usmani)