Chapter 4: Introduction to

Islamic contract law and

financial contracts
Haniffa/Hudaib: Islamic Banking and Finance. An Introduction
Definitions of contract in Islamic law

‘Aqd’ is the two parties taking upon themselves an undertaking to do

something. It is composed of the combination of an offer (ijab) and acceptance
(qabul). The making of ‘aqd’ is connecting in a legal manner, one’s offer (ijab)
and acceptance (qabul) with the other, in a way which will be clear evidence of
being mutually connected.

• A precise definition of contract only emerged in the 19th century in the

Islamic Civil Law Codification of the Ottoman Empire, namely Majallah al-
ahkam al-adliyyah (also known as Mejelle) under Articles 103-104.

2
 Pillars of Sharī‘ah Contracts

The pillars (arkan) of contract in Sharī‘ah are:

1. Form (sighah): The form of any contract in Islamic law is offer and
acceptance (ijab and qubul) (offer and acceptance).
2. Parties to the contract (al-aqidan): The parties to the contract
should have the ability or capacity to enter into a valid contract
3. Subject matter and price of the contract (al-ma’qud alaih): The
price of the contract is usually in the form of a consideration, which
may or may not necessarily be money
4. Intention to create legal relations and meeting of minds
Elements of a valid contract – offer and acceptance
Offer (ijab)
• A specific action that reflects consent or willingness by one of the
contracting parties done either in writing or verbally

Acceptance (qabul)
• Represents a statement uttered indicating assent to the offer

Offer and acceptance may be concluded by representatives or modern

communication systems, e.g. telephone, telex, fax, email and letter.

4
Elements of a valid contract – subject matter

1-Existence 2-Lawfulness
• Object of the contract must exist, except
• Object of the contract must be lawful
in the case of deferred delivery sale and
and permitted for trading purposes as
manufacturing contracts.
per shari’ah.

3-Deliverability 4-Precise determination

• Indicates that the object of the contract • Validity of contract depends on accuracy
can be certainly delivered as promised. of the object in terms of quantity,
quality and value.

5
Affirmative Evidence on Contract
Fulfilling contractual agreements:
Evidence from the divine Qur’an

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

• 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.
 Classifications of Contract in Islamic Law

• A contract of sale is classified according to

- its nature
- its circumstances
- its legal consequences
Classifications of Contract According to Its Nature

• Contracts can be classified into:

- Unilateral contracts (‘aqd infiradi)
- Bilateral contracts (‘aqd thuna’i)
- Quasi contracts (shibh al-‘aqd)
Classifications of Contract According
to Its Nature
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 (sale contract)

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

created by the law despite the absence of a contract (when we
get to the court.)
 Classifications of Contract According
to Its Nature

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
Classifications of Contract According
to Its Nature
Common Contracts in Islamic Law

Table 2.1: A List of Common

Contracts in Islamic Law
 Classification of Contract According to
its Circumstances

• 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.
 Classification of Contract According
to Its Legal Consequences

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)
• Withheld Contract (Mawquf)
Classification of Contract According to
Its Legal Consequences

Valid Contract (Sahih), are irrevocable you cant end the

contract.

• 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. (four pillars contract are met).

• A valid contract is a legally binding contract

 Classification of Contract According to Its Legal
Consequences

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)

Contract invalid in both form and/or substance.
 Classification of Contract According
to Its Legal Consequences

Binding Contract (Lazim) “all valid contracts are lazim”

• Binding if sound in substance and description

• Binding contract is enforceable under the law
• A binding contract can either be revocable or irrevocable “you can end the
contract.”

Withheld Contract (Mawquf) , when the contract awaiting for approvals

needed.
• When a binding contract is concluded by someone who does not own the
property, the contract may be dependent on the final approval of the real
owner of the subject matter.
 Forbidden Contracts in Islamic 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•bai‘
bai‘ munabazah and gambling including:
al-habl-il-hablah
•bai‘ muhaqalah •bai‘ al-mulamasah
•bai‘ malaqih •bai‘ al-munabadhah
•bai‘ madhamin •bai‘ al-Hisat
Forbidden Contracts in Islamic Commercial
Transactions “because it involves uncertainity, gesh,
 Forbidden Contracts in Islamic Commercial
Transactions

Riba
• Definition of Riba:    ‫ا**لربا‬
• Riba in the Arabic language literally means increase. However, according to the specific
Shari’ah definition, it means unlawful increase ‫ا**لزيادة ا**لمحرمة‬. Under today’s literature and
terminologies, riba commonly refers to interest and usury.
• The Islamic Fiqh Academy which was initiated through the OIC (Organization of the Islamic
Conference), was established to bring scholars from around the world in order to address
current issues and concerns. During the 2000 meeting, the OIC reaffirmed the consensus of
the historical prohibition of interest. Riba is one of the core concerns in Islamic finance.
• In order to avoid riba, many financial alternatives have been adopted over the centuries.
• Although scholars describe rationales as to why riba may be prohibited, the sole reason for
sincere Muslims to refrain from riba is to conform to what the Law Maker has legislated.
 Forbidden Contracts in Islamic
Commercial Transactions

Riba
• Interest in Judaism and Christianity
• The prohibition of interest is not something exclusive to Islam. Jews and Christians were likewise given
instructions in their scriptures which forbade them to deal with interest or usury. Although other faiths may
have had aversion to interest or usury, only Judaism and Christianity are singled out here due to the common
historical link between the three faiths. Below are some passages from the present day Bible. 
• Old Testament
• If you lend money to one of my people among you who is needy, do not be like a money lender; charge him no
interest (Exodus 22:25).
• Do not take interest of any kind from him, but fear your God, so that your countryman may continue to live
among you (Leviticus 25:36).
• Do not charge your brother interest, whether on money or food or anything else that may earn interest
(Deuteronomy 23:19).
• Hath given forth upon interest, and hath taken increase: shall he then live? He shall not live: he hath done all
these abominations; he shall surely die; his blood shall be upon him (Ezekiel 18:13).
 Forbidden Contracts in Islamic
Commercial Transactions

Riba
• New Testament 
• But love ye your enemies, and do well, and lend, hoping for nothing again; and your reward shall
be great, and ye shall be the children of the Highest: for he is kind unto the unthankful and to the
evil (Luke, 6:35).
• In Judaism and Christianity, lending money in order to receive a profit was strongly condemned. In
the Talmud, Ezekiel condemned interest as an abomination.  He also likened usurers to people
who shed blood. In Judaism, the distinction was made between Jews and gentiles. They tolerated
charging interest to gentiles, yet, were forbidden to practice it with their own fellow brethren
(Deuteronomy 23:20).
• Pope Alexander III (12th Century) excommunicated usurers, which in that period was seen as an
extremely harsh punishment. In 1317 the Council of Vienna took a strong stance and issued a law
that usurers were to be excommunicated. However, by the fifteenth century in Europe, usury
practices gradually gained ground and acceptance.
 Forbidden Contracts in Islamic
Commercial Transactions

Riba
• Riba in Islam
• Riba is strongly prohibited in Islam. The many verses of the Qur’an leave no
question in this regard: “Allah has permitted trade and forbidden riba.”
(Qur’an: Surah Al-Baqarah 2:275). The verses prohibiting riba are located in
four Surahs of the Qur’an; Surah Al-Baqarah 2:275-276, 278-280; Surah Aal
Imran 3:130; Surah An-Nisaa 4:161 and; Surah Ar-Room 30:39.
• Riba is further elaborated on in the Prophet’s Sunnah. Numerous hadiths explain
the details surrounding riba. In a hadith narrated by the Prophet’s companion
Jabir: “Allah’s Messenger cursed the one who accepts riba, the one who gives it,
the one who records it and the two witnesses to it, saying, ‘They are all the
same.’” (Collected By Muslim).
 Forbidden Contracts in Islamic
Commercial Transactions

Types of Riba Transactions

• There are two major categories of riba.

• The first category is known as Riba An-Nasee’ah which relates
to riba in debt. It increases with time (e.g. interest on borrowed
money). This is the most common type of riba today and it relates to
return of money on money at any rate (fixed or floating, compounded
or simple interest).
• The other category is Riba Al-Fadl which refers to riba in exchange.
This type of riba refers to the six commodities (e.g. Gold) mentioned
in the hadith.  
 Forbidden Contracts in Islamic
Commercial Transactions

Types of Riba Transactions

• Riba An-Nasee’ah - Riba in Debt

• This form of riba was well known in jahiliyah (pre-Islamic era of ignorance). When the date of maturity
neared for one’s debt, it would be said to him, “pay up, or pay riba (increase)”. Due to deferment in
repaying the debt, the debt would increase. It would continue to accumulate as compounded interest
until it doubles and so on.
• Another practice from the jahiliyah period included the loaning of money with a fixed increase in the
return. For example, one would borrow, 10 gold coins (Dinars) with the condition of returning 12 gold
coins at a future date.
• From the above description, we see how riba an-nasee’ah is equivalent to interest. For example, it
includes the use of credit cards and “interest free” periods, as the date of maturity passes, interest is
incurred. Likewise it is typical of bonds, or loans from conventional banks today which lend money
with the condition to be paid back with an increase of a certain percentage in the future, at a variable
or fixed interest rate.
 Forbidden Contracts in Islamic
Commercial Transactions

Types of Riba Transactions

• Riba Al-Fadl - Riba in Exchange  
• Although gold and silver were the real currency at the time, the Prophet described
certain commodities that relate to riba. These commodities are prohibited to
exchange, same for same, unless they are of equal amount, without increase.
One hadith states, “Gold with gold, silver with silver, wheat with wheat, barley with
barley, dates with dates, and salt with salt; same quantity for same quantity, equal
for equal; transaction being made hand to hand (i.e. on the spot payment)” (Muslim).
• Some scholars have stated that these commodities are only limited to
the six mentioned. Other scholars, by making Qiyas (analogy), have stated that it can
also include other commodities that can be weighed, or other food, or specific food
which can be stored similar in nature to the six.
 Forbidden Contracts in Islamic
Commercial Transactions

Types of Riba Transactions

• Riba Al-Fadl - Riba in Exchange  
• However, gold and silver are the universal tenders like cash money today. The remaining four commodities may
have been used in a similar fashion to currency.
• Another hadith mentions, “Do not sell gold for gold unless it is the same amount for the same amount, and do
not make one amount greater than the other. Do not sell silver for silver unless it is the same amount and do not
make one greater than the other.” (Bukhari and Muslim).
• The following narration sheds light on this form of riba with the exchange of these types of commodities.
A hadith mentions, “Once Bilal brought Barni (a kind of dates) to the Prophet and the Prophet asked him,
‘From where have you brought these?’ Bilal replied, ‘I had some inferior type of dates and exchanged
two Sa’s (approximately 6 kilograms) of it for one Sa’ (approximately 3 kilograms) of Barni dates in order to
give it to the Prophet to eat.’ Thereupon the Prophet said, Beware! Beware! This is definitely Riba! Don’t do
so, but if you want to buy (a superior kind of dates), sell the inferior dates for money and then buy the
superior kind of dates with the money” (Bukhari).
• This hadith shows the prohibition of exchanging the same commodity of a different measurement, yet it also
displays the alternative solution. That is to sell the dates, and buy the other dates with the money.
 Forbidden Contracts in Islamic
Commercial Transactions

Types of Riba Transactions

• Riba Al-Fadl - Riba in Exchange  
• The commentator of Sahih Muslim, Imam Nawawi, has summarized these rules
in the following way:
• When the underlying ‘Illah of the two goods being exchanged is different, shortfall/excess
and delay both are permissible, e.g. the exchange of gold for wheat or dollars for a car.
• When the commodities of exchange are similar, excess and delay both are prohibited, e.g.
gold for gold or wheat for wheat, dollars for dollars, etc.
• When the commodities of exchange are heterogeneous but the ‘Illah is the same, as in the
case of exchanging gold for silver or US Dollars for Japanese Yen (medium of exchange) or
wheat for rice (the ‘Illah being edibility), then  excess/deficiency is allowed, but delay in
exchange is not allowed. (Ayub 2007, p.52)
Forbidden Contracts in Islamic
Commercial Transactions
Wisdom behind the prohibition of riba as put forward by some scholars 
• It goes against mutual cooperation, generosity, and spirit of
partnership.
• Acquisition of property by wrongful means and harm to the needy.
• Removal of the possibility for injustice and exploitation.
• Drives the capital-owner away from enterprise and real economic
activities that contribute to the welfare of society (e.g. commerce,
manufacturing, construction and so on)
• Money is meant to be a medium of exchange and standard of
value for other goods. Riba violates the entire rationale behind
money and diverts money from doing what it is meant to do.
2. The Prohibition of Gharar (Uncertainty)

• Gharar has a broad scope and is not limited to one

simple definition. For our purposes here, it relates to
excessive uncertainty or ignorance by way of a
contract, or the goods involved in a sale, the price,
ownership, possession of goods, deliverability, dates
of exchange etc. A hadith collected by Muslim
narrated by Abu Hurairah states, “The Prophet
forbade selling by way of tossing stones to settle a
sale (Al-Haasah), and the sale of Gharar.”
Minor and major Gharar
Minor Gharar (permissible)
• Gharar has been categorized into two categories,
namely major and minor. It is expected that minor (or
trivial) accounts of gharar will exist and for that
reason it is tolerated and not given concern. Such is
the case of catching a taxi, there is an element of
uncertainty in the price as it rises with the mileage,
yet this is a minor form of uncertainty and is
permissible. Another example is buying fruit without
peeling the skin to see inside.
Major Gharar (prohibited)
• Causes for alarm are the major or substantial forms of
gharar which are clearly condemned from a Shari’ah
perspective. Major Gharar will be simply referred to
• Gharar can generally refer to the following:
• Lack of Transparency -The Shari’ah stipulates that transparency
must exist in order for contracts to be legitimate. For example,
the terms of the contract must be clear to both parties involved
in order to be just and fair. Under such measures, individuals are
protected from fraud, deceit and exploitation. “contracts that
include some articles that is not clear.”
• Deception - Gharar can also imply deceit. “when the traders
shows the nice fruits at top and hide the bad ones from the
customers.”
Once Prophet Mohammad came upon a heap of grain in the
market of Madinah and thrust his hand onto it. His fingers felt
dampness. On being asked, the trader replied that rain had
fallen upon it. The Prophet observed, "Why did you not then
keep (the wet portion of) it above the dry grain, so that people
may see it? He who deceives, has nothing to do with me”
(Muslim). Therefore, relevant information cannot be withheld.
• Selling what you do not have “it includes
uncertainty.”
Part of Gharar is selling what is not in one’s
possession. The common example of this is the selling
of the fish in the ocean which has not been caught
yet, or selling vegetables that the seller is yet to
purchase (i.e. they are not in possession or
ownership). This can lead to settlement risk and is
therefore a form of gharar. One should therefore
catch the fish and then sell it, or buy the vegetables
from a wholesaler, and then sell them to avoid the
risk of uncertainty.
An exception to this rule is a Salam contract (Bai’ As-
Salam) and Istisna. which relates to farm produce
which has not been harvested yet. Such a contract is
paid up-front and an agreed upon amount of goods
• Ignorance - The buyer should have relevant
information about the goods they intend to buy or
the contract they intend to sign. This is why it is
important to inspect the goods one is about to buy.
With regards to what the buyer is buying, the buyer
should know (for example) the quantity, the
attributes, species etc. Or in the case of a contract,
both parties should have a sufficient understanding of
the details and outcome of the contract in order to
remove any doubt.
• Unspecified Price - The price of the sale should be
stipulated. This is important if the goods are
purchased on credit, in order to avoid disagreement
at a later date.
• Unspecified dates - As for the delivery of goods, the
• Analogous to gambling (maysir)
• Maisir (game of chance) is regarded as gambling because the outcome
is unknown and clearly involves Gharar.  The practice of Maisir is
declared forbidden in Qur’an (2: 219). Therefore, according to the
Shari’ah, such games of chance are to be avoided. An example of this is
speculation in short selling, conventional methods of forwards,
futures, options and other derivative transactions where future
delivery of underlying assets is uncertain (and usually settled in cash)
as being forms of Maisir.
• Although excessive Gharar is condemned by the Shari’ah, this does not
rule out levels of risk by way of entrepreneurial risk and risk associated
with calamities (such as natural disasters). Systematic risk and
unsystematic risk will be covered in more detail in the following weeks.
• Complexity in Contracts
• Undue complexity in contracts or interdependent contracts where two
sales are combined in one are not permitted. (e.g. I will sell you A as
such a price, if you sell me B at such a price).
 3. Sanctity of Contract (cont)

• If two or more parties come together for a partnership (e.g.

musharakah), all parties should be aware of their profit-sharing ratio,
underlying assets involved, and other conditions of the contract.
• The parties involved must mutually agree on the sale or contract,
albeit orally or preferably in written form, without coercion.
• Contracts must be in accordance with Shari’ah principles. Therefore,
investments considered unethical, unlawful (haram), unjust etc,
would not be considered. Although riba and gharar may not be
involved, one must make sure that other unlawful practices are not
present. For example, it is prohibited to finance a casino or deal with
alcohol etc.
 Forbidden Contracts in Islamic
Commercial Transactions

Bai‘ al-Gharar

Classical examples of gharar mentioned in the Sunnah include:

• Birds in the sky.
• Fish in the sea
• An unborn calf in its mother’s womb
• Unripe fruits on the tree
• A runaway animal
• Milk in the udder of an animal without measurement
 Forbidden Contracts in Islamic
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
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.

Case study: Riba & Gharar today
Identify role of Riba & Gharar in:
I. Global Financial Crisis (GFC)
II. European debt crisis (EDC)
III. Other examples?