Supplementary

Contracts in Islamic
Finance

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Wakala
Wakala - ‫وكالة‬
• Literal meaning: looking after or taking custody.
• Technically, it is the act of one party delegating the other
to act on its behalf in what can be the subject matter of
delegation.
• It means to appoint some one to take charge of
something; to leave an assignment in some other
person’s care.
• It is possible for those activities that can be performed
by the delegating person himself.

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Wakalah (Agency)

• Wakalah refers to a contract where a party, as principal (muwakkil),

authorises another party as his agent (wakil) to perform a particular task
on matters that may be delegated, with or without imposition of a fee.
• The inherent nature of wakalah is the delegation of powers to, or
authorisation of, the agent by the principal, which gives rise to the agent
having fiduciary duties (amanah) towards the principal within what he
has been authorised to do.
• It is a trust contract, so the agent is responsible to discharge his
responsibilities honestly, to the best of his ability.

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Wakalah (Agency)

A wakalah contract shall be binding in any of the following situations:

(a) the wakalah contract involves rights of a third party;
(b) the wakalah contract involves a fee (wakalah bi al-ujrah) to be paid
to the agent;
(c) the agent has commenced the work that he has been authorised to
do and discontinuance of the work would cause the principal or the
agent to suffer damages; or
(d) the principal and the agent have agreed not to terminate the
wakalah contract within a specified time.

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Wakalah (Agency)

•
•
•

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Components of Wakalah

There are three main elements upon which wakalah are based: the principal (al
muwakkil), the agent (al wakil), the subject matter (al muwakkal fih).

The form of wakalah comprises any act that customary practices traditionally
consider a delegation of the right to acting by someone on behalf of the other.

Such delegation comprises of offer and acceptance which has no standard form of
wording and may be expressed through words, writing, messaging or gesture.

In accepting non-paid wakalah, silence is also considered as sufficient acceptance,

while a negative response is an indicative of rejection of wakalah.

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Wakala Cont.
• Agency services may be provided against a consideration, or without
it – compensatory or non-compensatory.
• Fee charged may be
• Fixed, as a percentage of capital, or lump sum;
• As a monthly or annual compensation; or
• Variable, as a percentage of profit (as bonus);
• May comprise both fixed and variable elements.

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 Wakala tul Istithmar
(‫)وكالة االستثمار‬
• Different types of Wakala, most
commonly used in IBs is Wakala tul-
Istithmar.
• It is to appoint an expert fund manager
for investment of one’s funds against a
pre-determined fee for pre-decided
services and duties. This fee may be
given in lump sum or as a monthly or
annual remuneration.

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Wakalah tul-istithmar (investment agency)

• The agent must not guarantee the capital or return on the investment in
any form.
• In the event of the agent’s misconduct, negligence, or breach of
specified terms that results in a lower profit rate than the expected
profit rate of such investment, the agent shall–
(a) repay the investment capital;
(b) pay the actual profit up to the event of breach; and
(c) compensate such loss and damage which the principal is entitled.

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Application of wakalah with other
contracts

1- Arrangement of wakalah with

kafalah (guarantee)

2- Arrangement of wakalah with

rahn (collateral)

3- Application of wakalah with

other contracts or arrangements.
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Kafalah
Kafalah (Guarantee)

• Kafalah generally means a guarantee. It is the act of someone adding him self to
another person and making him self liable to perform the responsibility. It is defined
as a contract where the guarantor conjoins the guaranteed party in assuming the
latter’s specified liability.
• In other words, kafalah is a contractual guarantee given by the guarantor to assume
the responsibilities and obligations of the party being guaranteed on any claims
arising thereof.
• The specific inherent nature of kafalah is to provide assurance on the fulfilment of
an obligation of the guaranteed party’s liability. Kafalah is binding on the guarantor.
• This principle is also applied in loan guarantees whereby the guarantor assumes the
liability of the debtor when the debtor fails to discharge his obligation.

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Kafalah (Guarantee)

Components of kafalah:
• Contracting parties, namely the guarantor (kafil), the beneficiary (makful lahu), and
the guaranteed party (makful `anhu);
• Offer (ijab) by guarantor; and
• Subject matter of kafalah.
Contracting parties:
• The guarantor shall have the legal capacity to enter into the kafalah contract.
• The contracting parties in the kafalah contract shall be a natural person or a legal
entity.
• A guaranteed party may be guaranteed by more than one guarantor.

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Kafalah (Guarantee)

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Legitimacy of guarantees and their
relevance to contracts
A contract of guarantee is permissible in contracts of exchange, e.g.
a contract of sale

Such a guarantee contract does not affect the validity of the original
contract in which it is required.

It is permissible to stipulate a guarantee into the body of an original

at one time, because guarantee is appropriate to, or relevant in
contracts.

There is no objection in Shari'a to include a number of guarantees in

one contract, such as incorporating a personal guarantee together
with a pledge of security in the same contract

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Arrangement of kafalah with other contracts or concepts

Kafalah may be arranged with other Shariah contracts or concepts, including:

benevolent
exchange- agency partnership wa`d (promise
(tabarru`at)
based contract contract contract / undertaking)
contract

provided that requirements for the arrangement of kafalah with such contracts/
concepts are observed.

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Hibah
Hibah (gift)

Hibah is a benevolent contract for the unilateral transfer of

ownership of an asset, hereinafter referred to as a hibah asset,
from a donor to a recipient without any consideration.

Hibah is a form of benevolent (tabarru`) contract. The inherent

nature of a hibah is the unilateral transfer of ownership of a
hibah asset from the donor to the recipient without any
consideration.

In the context of an Islamic financial transaction, hibah may be arranged

with other Shariah contracts or concepts, namely ijarah, mudarabah,
musharakah, wakalah and qard. An Islamic financial institution may
grant hibah to its customer at its own discretion but subject to
conditions specified by Shariah requirements.

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Hibah (gift)

A hibah is revocable by the donor prior to–

• The recipient taking possession of the hibah asset; or
• Fulfilment of the condition(s) stipulated in the hibah arrangement in the case of
conditional hibah.
A hibah granted by a father to his child is revocable anytime except in the following
circumstances–
• Ownership of the hibah asset has been transferred to a third party; or
• The hibah asset is encumbered or subject to claim by a third party.

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Hibah (gift)

Components of hibah:
Hibah arrangement shall consist of the following components:
(a) parties involved, comprising donor and recipient;
(b) offer (ijab) of hibah; and
(c) hibah asset.
Parties of hibah:
• The parties involved in a hibah arrangement shall be a donor and a recipient who is a natural
person or a legal entity.
• The donor must have the legal capacity to perform a benevolent act (ahl li al-tabarru`).
• In the event that a recipient has no legal capacity, a parent or legal guardian of the recipient
may accept and take possession of the hibah asset on his behalf.
• Any party to a hibah arrangement may act through an agent (wakil).

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Conditions of Hibah

• A hibah arrangement must be entered into through an offer of a hibah by the donor.
• The offer may be expressed orally, in writing or by any other methods recognised by
Shariah.
• An asset in a hibah arrangement shall be in the form of:
• a tangible or intangible asset;
• a movable or immovable asset;
• a share or an undivided interest in an asset
• An asset in a hibah arrangement must meet the following conditions:
• the asset must be recognised by Shariah, valuable, identifiable and deliverable; and
• the asset must already be in existence and owned by the donor.
• an asset to be received in the future by the donor is allowed to be granted as a hibah.
• An asset belonging to a minor shall not qualify as a hibah asset.

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Hibah in Profit Distribution

In the event of lesser than expected profits realized by savings and

investment account holders of an Islamic bank, the bank may offer its
depositors a certain amount as Hiba, subject to the following conditions:
• The Hiba amount would be from the bank’s own share of the profits
• The Hiba amount would be unconditional
• It would be entirely at the discretion of the bank
• It would not be contractually pre-agreed with the depositors
• The bank may meet the shortfall in profits either fully or partially
• The Hiba amount would be given to the entire Common Mudaraba Pool,
distributed according to the weightages of each product category
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Wa’d
Wa’d (promise)

• Wa`d is a unilateral promise which refers to an expression of

commitment given by one party to another to perform certain
action(s) in the future. Wa`d is a unilateral promise and it is not
a contract.
• A wa`d attached to a condition, time, price, conduct or event
shall be binding on the promisor. In this case, the wa`d shall be
binding from the date the promisor makes the wa`d.

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Wa’d (promise)

Parties in Wa’d:
• The parties involved in wa`d are the promisor (wa`id) and the promisee
(maw`ud lahu).
• The promisor shall be a natural person or a legal entity that must have
the legal capacity to execute the subject matter of wa`d.
• The promisor shall express a commitment to perform certain actions in
the future to effect wa`d. The promisor’s expression of commitment
may be expressed orally, in writing or by any other method recognised
by Shariah.

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 • The subject matter of wa`d shall be a commitment to
perform specific action(s) at a specified time in the
future.
• The subject matter of wa`d must be Shariah
Subject matter compliant.
• At the inception of wa`d, the promisor and promisee
of Wa’d may agree that the promisor may be granted an
extension of time to execute wa`d, subject to any
agreed conditions. If both parties involved agree for
the extension of time to execute wa`d, the promisor
shall be bound to fulfil wa`d at the new specified
time.
• Wa`d shall not be provided in exchange for a counter-
value such as a fee to the promisor.

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Binding Wa’d

• The promisor shall not unilaterally revoke his wa`d.

• The promisor shall fulfil his wa`d in accordance with the specified
condition.
• The promisee has a right to claim compensation for any actual loss
suffered due to the failure of the promisor to fulfil his wa`d. In this case,
the promisee’s actual loss shall be determined either by–
• An authoritative body; or
• A methodology accepted as customary business practice (`urf tijari).

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Arrangement of wa`d
with other contracts
or concepts
1- Arrangement of wa`d with a security
deposit (hamish jiddiyah)
2- Wa`d in Relation to Transfer of Ownership
3- Wa`d and Forward Currency Exchange
4- Wa`d in Musharakah, Mudarabah and
Ijarah
5- Wa`d and Rahn
6- Wa`d and Hibah
7- Wa`d and Kafalah

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Case study: Using Wa’d in vehicle financing by
Bank Muamalat
• Muamalat Vehicle Financing-i is a vehicle financing facility based on Shariah
contract of Murabahah to the Purchase Orderer (MPO).
• This product offers purchase of vehicle to customers with up to 100% margin of
financing.
• This facility is calculated based on fixed rate basis and the customer’s vehicle will
be pledged as collateral against the financing.
• The main Shariah contract pertinent for this facility is Murabahah (Murabahah to
the Purchase Orderer). Murabahah is a sale and purchase contract of assets
whereby the cost and profit margin (mark-up) are made known.
• Under this contract, the customer has made a binding promise (Wa`d Mulzim) to
purchase the vehicle from the Bank, subsequent to the Bank having taken
possession of the vehicle.

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Rahn
Rahn (pledge/collateral/pawn)
• Rahn refers to a contract where a party, as pledgor (rahin) pledges an asset as
collateral (marhun) to another party, a pledgee (murtahin) to fulfil an obligor’s
liability or obligation (marhun bih) owing to the pledgee in the event of default of
such obligor
• The inherent nature of rahn is the assurance that the liability or obligation owed
by the obligor to the pledgee will be fulfilled in the event of a default as agreed in
the terms and conditions of rahn.
• Rahn is binding on the pledgor upon entering into the contract. The pledgor does
not have the right to revoke the rahn contract without the consent of the
pledgee.

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Rahn (pledge/collateral/pawn)
• Rahn or pawning is one the most practical means of ensuring against
default in payment of a debt.
• The documentation and guarantee (kafalah) provide less certainty
with regard to the creditor’s right to get repayment of the debt.
• The contract of rahn is a voluntary charitable contract (tabarru’),
since the pawned object is given without financial compensation.

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 Components of rahn:
A rahn contract shall consist of the following
Rahn components:
(pledge/ (a) the pledgor and pledgee (collectively
collateral/ referred to as contracting parties);
(b) the offer (ijab) and acceptance (qabul) to
pawn) enter into the rahn contract; and
(c) the subject matter of the rahn contract.

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Forms of rahn contract
The contract of rahn (pawning) may exist in one of three forms:
1: Rahn Originating from Debt-generating Contract
• For example, a seller in a credit sale may stipulate a condition that the buyer must pawn
an object in lieu of the price established as a debt.
• All Muslim jurists agree that such pawning is valid, as it serves a valuable economic
purpose.
2: Rahn Originating after Establishment of Debt
• Jurists also agree that this form of pawning is valid, as a means of insuring an existing
debt.
3: Rahn Originating Prior to Establishment of Debt
• For instance, a person may pawn some property with another prior to getting a loan
from that person.

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Liquidation of rahn:
• The liquidation of collateral shall be carried out in accordance with
the terms of the agreement entered into by the contracting parties.
• The contracting parties may stipulate at the time of entering the rahn
contract that the owner authorises the pledgee, his agent or other
party to perform the liquidation process.
• In the absence of any stipulation, any person who performs the
liquidation process must obtain prior approval of the owner.
• The liquidation of collateral may be performed in whole or in part.

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Application of rahn with other contracts

Murabahah and
Qard Istisna` Ijarah
tawarruq

Mudarabah,
Musharakah, or
Kafālah Wa`d
Wakalah bi al-
istithmar

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