Islamic Law of Contract

Guiding Principles of Islamic Finance

Key Principles of
Islamic Financial
Transactions

Shari’ah Non-
Halal
Compliant Risk Sharing Asset Backing
Investments
Transactions

Riba

Gharar

Mysir
The difference between interest (riba)
and sale (bai)
 What is the Difference between riba and bay?
 In normal sale  seller, buyer, subject matter and price
 The seller may produce the required product (subject matter) him.
 The seller may buy it from other seller and sell it on cost+profit.
 In case of riba loan is extended on a condition of return of profit and interest
and no efforts of the lender are involved.
Riba and bai …cont…

 In Bay, the profit exchanged between buyer and seller on an equal footing 
seller gets compensation of land, labour, and entrepreneurial skills; buyer get
the benefit of goods.
 In riba, the lender secures his principal and interest while the borrower will
be paying interest for the grace period that he received.
  he may or may not be able to provide interest e.g. business incurs losses
Imam Nawawi On Identification of Riba

 When the underlying illah of the two goods being exchanged is different,
shortfall/excess and delay both are permissible.
 When the commodities of exchange are similar, excess and delay both are
prohibited.
 When the commodities of exchange are heterogeneous but the illah is the
same, as in the case of exchange of gold for silver or USD for Yen (medium of
exchange), or wheat for rice (illah being edibility), then the excess or
deficiency is allowed as long as on spot.
 Identifying Ribawi Transaction
Type 1 Type 2 Type 3

Commodity – Money Money 1 for Money 1 Money 1 for Money 2

Can be Deferred No deferment No deferment
Can charge Surplus No Surplus Can have surplus
Commodity 1 for Commodity 1 for
Commodity 1 Commodity 2
No deferment No deferment
No Surplus Can have surplus
 House sold for PKR 10m and the payment is deferred for 10 years where the
borrower will pay in monthly installments.
 A 1998 model Corolla exchanged for 2010 Mehran on spot.
 12 grams of gold exchanged for 500 grams of silver on spot.
 USD 100 exchanged for PKR 17,000 on spot and PKR 18,500 after 1 month.
 PKR 100,000 exchanged for PKR 100,000 in deferment.
 I pay you an amount equal to 100kgs of silver with grace period of 10 months
while you have to pay me an amount equal to 10kgs of silver every month.
 I pay you an amount in PKR equal to USD 100,000 with grace period of 10
months while you have to pay me an amount in PKR equal to USD 10,000 each
month.
Prohibition 2: Gharar (Uncertainty)
Gharar (Uncertainty or Ambiguity)

 Gharar – Uncertainty, ambiguity

 Leads to obtaining one’s property unlawfully
 Technically, the element of gharar arises at the time of contract formation –
Specifically sale contract.
 Such contracts are attractive to the buyer in its form but
ambiguous/uncertain in its substance.
 Is Gharar different from Risk?
 Gharar is uncertainty arise due to missing elements in the contract.
 Risk is type of uncertainty that does not arise because of missing elements in the
contract but because of external factors.
Maysir
Mysir

 Earning by chance.
 Activities such as gambling.
 Winner wins money without any efforts and loser lose without any fair
compensation – even the win/lose was by chance.
 Islam encourages earning from real activity through honest efforts and
prohibits confiscation others money by chance.
 Example - Stock Market Speculation
Conditions of a Contract

 Offer
 Acceptance
 Consideration
 Intention
Types of Contract

 Unilateral
 Bilateral
 Expressed
 Implied
Key Features of Islamic Finance
Contracts
 There are at least two parties
 There is offer and acceptance by both parties on the
terms and conditions of the contract. Acceptance and
offer can come from any of the party.
 The modality of the contract must not contain Haraam
Practices.
 The terms of the contract should be achievable.
 All parties should be aware of the specification of the
object under consideration.
 The contracting parties should be mature and possess
sound mind.
Categories of Islamic Contracts

 Contracts of Exchange
 Contracts of Participation
 Supporting/Auxiliary Contracts
Common Islamic Finance Contracts
Save and Spend Mudharabah, Qard

Protection Wakalah

Investment Mudarabah
Islamic Contracts

Murabaha,
Trade (LoC)
Wakalah, Wadiah

Debt Based
Murabaha, Istisna,
Salam, Qard
Financing
Equity Financing
Musharakah,
Mudarabah
Sale and its types
Sale

 The Exchange of a thing of Value by another thing of a

value with Mutual Consent
Four Basic Rules to Judge the Validity of
Conditions in a Contract
 If the condition is not against the contract, it is
considered valid.
 A condition which is against the contract but is commonly
practiced in the market will be considered valid, provided
that it is not against the teachings of Quran or Sunnah.
 A condition that favors any one party will be considered
void.
 A condition that is against the contract, is not in the
market practice and not in the favor of any party will not
be void.
1. Valid Sale

Valid Sale

Contract (Offer and Delivery or

Subject Matter Price
Acceptance) Possession (Qabza)

Conditions
(Absolute Sale/Non
Contingent)

Express (In Past

Implied
Tense)

Capacity to
Contract
 Subject Matter

Subject Matter Existent Valuable

Capable of Capable of
Usable
Delivery/Possession Ownership

Specific and Seller Must have

Quantified title and Risk
 Price

Price

Quantified Specific/Certain
Delivery/Possession (Movable Assets
only)

Possession

Physical Constructive
2. Void Sale

 The sale will be considered void in the following cases:

 Offer and acceptance not executed properly
 Buyer or Seller has not capacity to contract
 No Possession of the Subject Matter
3. Defective Sale

 There are defects which case the contract to be void.

 If removed the contract will be considered Valid e.g.
 Conditions of the contract
 Subject Matter Conditions
 Price Conditions
 The buyer must not take the delivery of goods unless the rectification is made
in the contract.
Disliked (Makrooh) Transactions

 Those transactions which are disliked.

 When a third party intervenes to buy something which was under negotiation
of sale between other parties
Options (Khiyar)
1. Optional Condition (Khiyar al Shart)
 Provision of recession of contract with in given time period
 It can be option of the buyer or option of the seller.
 This Khiyar does not transfer to heirs.
2. Option of Inspecting Goods (Khiyar e Roiyyat)
 Buy after inspecting the commodity.
3. Option of Defect (Khiyar e Aib)
 If the goods contain defect, it can be returned.
4. Option of Quality (Khiyar e Wasf)
 The option with the buyer if the goods sold are not according to specification.
5. Option of Price (Khiyar e Ghaban)
 If the goods are far more expensive than the market price.
Recession of Contract (Iqala)

 When parties decide to rescind the contract mutually.

 In case of return of the product, the price will not change.
 There is no impact of the recession on third party.