Introduction to Islamic Banking and Finance:

Principles and Practice

M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 2

Islamic Contract Law

Learning Objectives
Upon completion of this chapter, the reader should be able to:

• Understand the underlying philosophy of business

transactions in Islam

• Explain the meaning of contracts, and the legal concepts

and theories of the various types of contracts in Islamic law

• Describe the classification of contracts, what constitutes a

contract of sale, and the legal capacity to enter into such
contract in Islamic law

• Analyze the main forbidden contracts in Islamic commercial

transactions.
 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.

• The Prophet Muhammad (PBUH) was a trans-territorial

trader

• Islam encourages people to earn a living through legitimate

means

• Islam emphasises the right to lawfully acquire property and

ensures that such rights are protected

• Fiqh mu’amalat proclaims all transactions to be permissible

if free of usury, deception, speculation, undue profits and
engaging in prohibited items
 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.
Lawful Earning Under the Sharī‘ah

• Islam states everyone’s livelihood should be lawful

• Islam gives a right of acquisition of property to all

• Regardless of the way one chooses to earn a living, the

form and substance must be legitimate

• The Sharī‘ah does not limit profit amount in business

However:

• Commodities should be sold at market prevailing rates

• It is prohibited for a trader to exploit buyers not aware of
the market price
 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.

The Right to Earn a Livelihood

• Divine Qur’an legislation gave right to earn legitimate wages

or transactions

• Manufacturing and commercial business explained by the

Prophet

• This has been a historic event in

Islam – the Prophet’s wife
Khadijah was an entrepreneur
in Mecca
 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.

The Prophet’s Companions Earned Their Living by:

• Being engaged in lawful trade (the most common form of

work during the era)

• Being engaged in agriculture/owning farmland

• Being involved in skilled crafts e.g. smithing, carpentry

• Undertaking professional, state-associated jobs e.g

teaching, administration of zakat and adjudication of
disputes
 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.

Unlawful Earnings Under the Sharī‘ah

• Excessive gains in business transactions, undue profits

• Excessive commission/service charges by some financial

institutions

• Exploitation of others while acquiring one’s property

• Money-lending involving usury

• Trade in prohibited items e.g. wine, pork, dead animals

 Learning Objective 2.1
Understand the
Business Transactions in Islam underlying philosophy of
business transactions in
Islam.
Unlawful Earnings Under the Sharī‘ah (continued)

• Short-measures in trade through underweight items

• Hoarding to inflate prices at a later period

• Adulteration of commodities and trading in defective items

• Misappropriation of public funds

• Gambling and lottery business

 Learning Objective 2.2
Explain the meaning of
Islamic Contract Law contract and the legal
concepts and theories of
the various types of
contracts in Islamic law

Definition of contract in Islamic law

• The term used for ‘contract’ in Arabic is aqd

• The meaning of the term ‘aqd

- To tie between two ends, to fasten, to link

- In Islamic law, it means agreement, commercial

arrangement, legal transaction, document or
deed
 Learning Objective 2.2
Explain the meaning of
Islamic Contract Law contract and the legal
concepts and theories of
the various types of
contracts in Islamic law

Definition of contract in Islamic law

The definitions for the term aqd are based on:

• General interpretation: any thing or disposition that is

intended to be performed by a person out of his/her own
will or through mutual agreement

• Specific interpretation: an agreement among parties

concluded through an offer and acceptance with the
consequences of binding legal obligation
 Learning Objective 2.2
Explain the meaning of
Nature of Contract and Related Terms contract and the legal
concepts and theories of
the various types of
contracts in Islamic law

All forms of contract fall under either Wa’ad or Muwa’adah

• Wa’ad is a binding unilateral contract where a party

promises or undertakes to carry out a unilateral contract

- The concept of wa’ad is based on fulfilment of promise

in all dispositions
- Most jurists consider fulfilling wa’ad as recommended
in financial transactions
- Maliki scholars believe that fulfilling wa’ad is
obligatory and enforceable

• Muwa’adah: a conditional/unconditional bilateral contract

 Learning Objective 2.2
Explain the meaning of
Affirmative Evidence on Contract contract and the legal
concepts and theories of
the various types of
contracts in Islamic law
Fulfilling contractual agreements:
Evidence from the divine Qur’an

• O you who believe! Fulfil (your) obligations.

• And fulfil (every) covenant. Verily, the covenant will be
questioned about.
• And fulfil the Covenant of Allah when you have covenanted,
and break not the oaths after you have confirmed them –and
indeed you have appointed Allah your surety. Verily! Allah
knows what you do.
• Except for the idolaters with whom you have a treaty, and who
have not subsequently failed you in aught, nor have supported
anyone against you. So fulfil their treaty to them for the end
of their term. Surely Allah loves the pious.
 Learning Objective 2.3
Describe the classification
Classifications of Contract in Islamic of contracts, what
constitutes a contract of
Law sale, and the legal capacity
to enter into such contract
in Islamic law

• Basic Sharī‘ah principles of contracts based on the

- general wellbeing
- economic justice
- equitable distribution of resources in the society

• A contract of sale is classified according to

- its nature
- its circumstances
- its legal consequences
 Learning Objective 2.3
Describe the classification
Classifications of Contract According of contracts, what
constitutes a contract of
to Its Nature sale, and the legal capacity
to enter into such contract
in Islamic law

• Contracts can be classified into:

- Unilateral contracts (‘aqd infiradi)
- Bilateral contracts (‘aqd thuna’i)
- Quasi contracts (shibh al-‘aqd)

• Muslim jurists have classified contracts as to if they are:

- Sharī‘ah-compliant contracts
- Contracts that contain some prohibited elements

Classifications of Contract According
to Its Nature
Common Contracts in Islamic Law
Learning Objective 2.3
Describe the classification
of contracts, what
constitutes a contract of
sale, and the legal capacity
to enter into such contract
in Islamic law

Table 2.1: A List of

Common Contracts in
Islamic Law
 Learning Objective 2.3

Classifications of Contract According Describe the classification

of contracts, what
to Its Nature constitutes a contract of
sale, and the legal capacity
to enter into such contract
in Islamic law
Main contract classification

• Unilateral contract (‘aqd infiradi): A contract initiated and

concluded by a single party which involves some form of
benefit being transferred to another party, usually without
consideration

• Bilateral contract (‘aqd thuna’i): A contract between two

parties with the necessary legal effect that makes terms
and conditions binding

• Quasi contract (shibh al-‘aqd): An arrangement or

obligations created by the law despite the absence of a
contract
 Learning Objective 2.3
Describe the classification
Classifications of Contract According of contracts, what
constitutes a contract of
to Its Nature sale, and the legal capacity
to enter into such contract
in Islamic law

Bilateral contracts are broadly divided into:

• Contracts of exchange (mu’awadat)

• Contracts of security (tawthiqat)
• Contracts of partnership (shirkah)
• Contracts of safe custody (wadi’ah)
• Contracts relating to the use of usufruct of an asset (ijarah)
• Contracts relating to the performance of a work or rendering
of specific services
 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to its Circumstances sale, and the legal capacity
to enter into such contract
in Islamic law

• The circumstances of a particular contract determine its

legal consequences

• The classification of contract according to its circumstances

involves the type of contract being offered:

• Sale contract when the incident involves simple buying

and selling

• Partnership contract when the contract involves joint-

venture - such as mudarabah, musharakah, etc.
 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to Its Legal Consequences sale, and the legal capacity
to enter into such contract
in Islamic law

This classification puts emphasis on the extent of validity or

binding nature of the contract.
The legal consequences of a contract may result in:

• Valid Contract (Sahih)

• Invalid or Deficient Contract (Fasid)
• Void Contract (Batil)
• Binding Contract (Lazim)
• Enforceable Contract (Nafidh)
• Withheld Contract (Mawquf)
 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to Its Legal Consequences sale, and the legal capacity
to enter into such contract
in Islamic law

Valid Contract (Sahih)

• A contract is deemed valid when it is concluded with an

effective offer and acceptance and the parties have the legal
capacity to do so.

• A valid contract is a legally binding contract

 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to Its Legal Consequences sale, and the legal capacity
to enter into such contract
in Islamic law

Invalid or Deficient Contract (Fasid)

A transaction where the basis of the contract itself is valid but
there are defects in its attributes that make it invalid and thus
unenforceable under the Sharī‘ah.
Contracts may become invalid under the following situations:
– If the contract is against public policy
– If the contract is illegal
– If the offer/acceptance/consideration calls for action
that violates the law – such as gambling, robbery,
etc.
– If the purpose of the contract is illegal
 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to Its Legal Consequences sale, and the legal capacity
to enter into such contract
in Islamic law

Invalid or Deficient Contract (Fasid)

A transaction where the basis of the contract itself is valid but
there are defects in its attributes that make it invalid and
thus unenforceable under the Sharī‘ah.

Void Contract (Batil)

A transaction where the basis of the contract itself is unlawful
and against the Shariah.
 Learning Objective 2.3
Describe the classification
Classification of Contract According of contracts, what
constitutes a contract of
to Its Legal Consequences sale, and the legal capacity
to enter into such contract
in Islamic law

Binding Contract (Lazim)

• Binding if sound in substance and description

• Binding contract is enforceable under the law
• A binding contract can either be revocable or irrevocable

Enforceable Contract (Nafidh)

• All binding contracts are enforceable under the law
• An enforceable contract relates to the rights of the parties
to
the contract

Essential Elements of Contract of Sale
Learning Objective 2.3
Describe the classification
of contracts, what
constitutes a contract of
sale, and the legal capacity
to enter into such contract
in Islamic law

1. Offer and acceptance: Must have mutual consent of the

parties

2. Subject Matter: What is exchanged must have value, be

permissible and be possessed by the trading parties

3. Consideration or Price: A form of exchange also known as

the price of the commodity

4. Legal Capacity of the Parties: The seller must have legal

capacity to engage in a contract of sale
 Learning Objective 2.3
Describe the classification
Contract of Sale (bai’) of contracts, what
constitutes a contract of
sale, and the legal capacity
to enter into such contract
in Islamic law

Meaning of Contract of Sale

• A contract of sale involves the exchange of property for a

well-defined consideration in accordance with the mutual
consent of the parties to the contract

• The consideration can be either in the form of money or

commodity or both.
• Nature of Contract of Sale The fundamentals of contract
(Pillars of Sharī‘ah Contracts) of sale is the same regardless
of any modern means
 Learning Objective 2.3
Describe the classification
Legal Capacity in a Contract of contracts, what
constitutes a contract of
(Ahliyyah) sale, and the legal capacity
to enter into such contract
in Islamic law

• Literally, ahliyyah means aptitude, fitness, suitableness,

competence, qualification, or absolute fitness
• In the juristic sense, ahliyyah is “the ability to acquire rights
and exercise them and to accept duties and perform them
accordingly”
• Main types of legal capacity of contractual transactions in
Islamic law:
1. Receptive legal capacity
(ahliyyah al-wujub)
2. Active legal capacity
(ahliyyah al-‘ada)
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

• Islamic law emphasizes fair dealing and mutual benefits

among parties undertaking business activity

• Qur’an and Sunnah prohibit certain contracts. Forbidden

contracts involve elements of riba, gharar and gambling
including:
• bai‘ munabazah • bai‘ al-habl-il-hablah
• bai‘ muhaqalah • bai‘ al-mulamasah
• bai‘ malaqih • bai‘ al-munabadhah
• bai‘ madhamin • bai‘ al-Hisat
Table 2.2: Forbidden
Elements in
Commercial
Contracts in Islamic
Law
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

Riba

• The term riba literally means usury, interest or a usurious

element in any transaction

• Any sale contract which is tainted with usurious elements,

however small it is, is prohibited under the Sharī‘ah

• The word riba is used several times in the Qur’an to refer to

interest-bearing transactions, which are prohibited in
Islamic law
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

Types of Riba Transactions

The two main types of riba transactions are:

• Riba al-nasi’ah (interest on delayed payment): An

unjustifiable increase for the deferment of repayment of a
loan, mentioned in the Qur’an

• Riba al-fadl (interest on excess in counter-value in trade):

Interest of an increase in the quantity of one of the
countervalues), which is clarified in the Sunnah

Forbidden Contracts in Islamic
Commercial Transactions
Figure 2.2: Classification of Riba
Learning Objective 2.4
Analyze the main forbidden
contracts in Islamic
commercial transactions
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

Why the Prohibition of Riba?

Riba is forbidden in Islam due to:

- Economic effects, e.g. keeping money idle and unproductive,

adding to miseries of the poor
- Social effects, e.g., cutting ties; creating enmity and hatred
between the poor and rich; spreading corruption
- Psychological and spiritual effects, e.g., arrogance, hard-
heartedness and exploiting needs of the poor
- On the state level, e.g. losing control over resources and
natural wealth
 Learning Objective 2.4
Analyze the main forbidden
Views of Bank Interest contracts in Islamic
commercial transactions

• Traditional View: Bank Interest constitutes riba as it

resembles riba al-nasi’ah

• Liberal View: Bank interest is not riba. It represents one’s

dividends for depositing money in bank accounts

• Most Convincing Position: The majority of jurists and

Muslims believe bank interest is equivalent to riba
6. Trade and Interest

• The Quran says: “Allah has allowed trade and

prohibited usury.”

Trade Usury
Risk-taking Interest
Amount of money based Fixed regardless of
on profit and loss profit and loss
Limited profit No limit
Full employment and No such thing
hardship
Leads to building of Leads to miserliness and
civilization selfishness
35
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

Bai‘ al-Gharar

• Speculative contracts which contain uncertain elements

• The power to sell is denied in the following circumstances in
order to avoid uncertainty:
- Things which, as the object of a legal transaction, do
not exist
- Things which exist but which are not possessed by the
seller or the availability of which may not be expected
- Things which are exchanged on the basis of uncertain
delivery and payment
 Learning Objective 2.4
Analyze the main forbidden
Forbidden Contracts in Islamic contracts in Islamic
commercial transactions
Commercial Transactions

Maysir or Qimar (Gambling or Games of Chance)

• Qimar (or maysir). Gambling involving the acquisition of

wealth by chance of winning the game or speculation
without consideration or compensation for such wealth

• Gambling can be defined as “a contract among two or

more persons involving the exchange of money or other
valuables depending upon the uncertain outcome of a
staged event”

• There is a link between gharar and qimar in terms of the

uncertain outcome of the game of chance
 Forbidden Contracts in Islamic
Learning Objective 2.4
Analyze the main forbidden
Commercial Transactions contracts in Islamic
commercial transactions

Why the Prohibition of Qimar?

• Reliance on accidental gains or luck

• Against Islam (livelihoods need to be earned legitimately)

• Qimar destroys livelihood of families; impoverishing the rich

and unfairly enriching the poor through prohibited means

• Hostility and hatred is usually generated among the players

• Induce players to take harmful drugs to cope with loss

• Qimar may lead to crime due to any loss of money

• Turns people away from Allah by neglecting teachings of Islam

‫•‬ ‫‪ ) declares:‬ص لهللا عليه وآ له وسلم ( ‪he‬‬
‫•‬ ‫‪ .‬ال إیمان لمن ال أمانة له وال دین لمن ال عهد له‬
‫•‬ ‫‪The person who is not trustworthy has no‬‬
‫‪faith, and the person who breaks his‬‬
‫•‬ ‫;‪promises has no religion‬‬
‫•‬ ‫‪ .‬إن حسن العهد من اإلیمان‬
‫•‬ ‫‪Maintaining promises perfectly is a sign of‬‬
‫;‪faith‬‬
‫•‬ ‫بر الوالدین مسلما ً آان أو آافراً‬
‫ثالث ليس آلحد الناس فيه رخصة ‪ً :‬‬
‫والوفاء بالعهد لمسلم أو آافر واألمانة الى‬
• Return what is placed in your trust for
safekeeping to the person who has
• trusted you and do not betray who has
betrayed you;
• Finally, he ( ‫ ) ص لهللا عليه وآ له وسلم‬specifies the
chief characteristics of hypocrites
• as follows:
• ‫ثالث من آان فيه فهو منافق وإن صام وصلى وحج واعتمر وقال إني‬
‫ من إذا حدث آذب واذا وعد‬: ‫مسلم‬
• ‫ أخلف وإذا ائتمن خان‬.
• Three (behavioural traits) if found in a
person, then he is a hypocrite even if he
• fasts, prays, performs bigger and smaller
pilgrimages, and says “I am a Muslim:”
• when he talks, he lies; when he promises, he
breaches; and, when trusted, he
• betrays.
• End of Chapter