Islamic Economics and Finance

Philosophical Foundation & Shari’ah compliant Business & Shariah compliant Insurance Contemporary Subjects &
Islamic Financial Market
Basic Rules Financial Contracts (Takaful) Shariah Compliance

Foundation & Basic

Concepts Murabahah Islamic Equity Market (Overview)

Islamic Economic System Salam & Istisna’a Money Market – Islamic Perspective

Sources of Shari'ah Ijarah Capital Market – Islamic Perspective

Key Prohibitions Mudarabah Shariah Compliant Stocks

Islamic Law of Contracts Screening of Shariah Compliant stocks

and Sale Musharakah
ISLAMIC LAW OF CONTRACT
CHAPTER 5
 Contents

 Introduction
 What is a Contract?
 Elements of a Contract
 Classification of Contracts
 Mode of creation
 Enforceability
 Formation
 What is an Islamic financial contract?
 The foundations of the Islamic Law of contracts
 Classifications of Islamic financial contract
 Contract of exchange
 Contract of security
 Contract of partnership (Shirkah)
 Contract of safe custody (Amanah)
 Contract of pertaining to utilization of usufruct (Ijarah)
 Contracts of pertaining to do a work such as Wakalah and Ju’alah

 Shariah requirements relating to the validity of contracts

 Introduction

 The law of contract is at the ethical heart of any commercial legal system.

 Islamic commercial law, known as fiqh al mu’aamalat in Islamic legal term, constitutes an important
branch of law dealing with issues of contracts and the legal effect(s) arising from a contract; be it a
valid, void or a voidable contract respectively.

 In Shariah, principles and rules of valid contracting help parties to conduct business free from Riba,
Gharar and other contractual vices.
 Introduction

Three generic types of undertaking could exist between two parties:

a. The Wa’d (Unilateral promise)

b. The Muwaada or Mua’hada (Bilateral promise)

c. The ‘Aqd (The contract)

 What is a Contract?

 In common law legal system, a contract (or informally known as an agreement in some jurisdictions) is an
agreement having a lawful object entered into voluntarily by two or more parties, each of whom intends to create
one or more legal obligations between them (to perform or not to engage in certain activities).

 A Contract is defined as “an agreement, whether express or implied, between two or more parties that the law will
enforce.”

 A legal agreement between two parties in which each agrees to do, make, buy, or sell a good or service, or in
which one party grants a right or undertakes an obligation, often in exchange for a fee.

 A contract is less commonly called a binding agreement.

 Elements of a Contract

1. Parties: Two or more legal parties acting as a seller and as a buyer or a debtor and a creditor

2. Consensus by way of Offer and Acceptance: The parties must reach conscious agreement, with a genuine
simultaneous intention and formal offer and acceptance.

3. Contractual capacity: The parties must be legally capable of concluding a binding contract.

4. Legality: The contract must be legal and may not contradict any statutory or Shariah/common law rule.

5. Physical possibility: The performance must be determinable and possible at time of conclusion.

6. Formalities: The contract must abide by any formalities set by law or by the parties themselves.
 Classification of Contracts

 Contracts are classified on the basis of;

a. Mode of creation

b. Enforceability

c. Formation
 Cont….

a. Mode of creation

1. Express Contract is one in which the agreement (offer and acceptance) is made in
words spoken or written.

2. Implied Contract is one in which the agreement (offer and acceptance) is made by
action and conduct of the parties.
 Cont….
b. Enforceability:

1) A Valid Contract is one which is legally binding and fully enforceable by the court because it satisfied all the
essentials of a valid contract.

2) An Invalid Contract is an agreement between the parties whereby the foundation of the contract is valid but the
attributes (any one or some) of the contract are unlawful e.g. if the object of the contract is unknown.

3) A Void Contract is a contract which has no legal effect whatsoever; it has no value in law.

4) A Voidable Contract is one which is not void in itself but which may be cancelled by one of the parties if he
chooses to do so. If the party with the power to reject the contract chooses not to reject the contract despite the
defect, the contract becomes valid and enforceable.
 Cont….

c. Formation:
1) Unilateral Contracts: Offerer wants performance in exchange for his promise.

 In other words a unilateral contract is defined, as a transaction by one party only or by which one
party binds himself e.g. contests and lotteries.

2) Bilateral Contracts: Offeror and Offeree exchange promises to each other. A contract is formed when
Offeree promises to perform.
 Islamic Financial Contract

 Until 19th century, no definition of contract is to be found in the articles of Islamic law. This is because
Islamic law never developed a general theory of contract.

 However, the Islamic Civil Law Codification which took place in the 19th century, namely the Majallah
al-Ahkam al-'Adliyyah and Murshid al-Hayran (the 1891 Egyptian version of the Ottoman's Majallah)
started to give a precise definition to a contract.

 The Majallah describes a contract as “legal contracting parties obligating themselves with regards a
given matter and binding themselves together with the same as result of connecting an offer with an
acceptance.”
 Islamic Financial Contract

 A financial contract in the context of Islamic Financial Institution business covers

legal contracts entered into between the Islamic banks/financial institutions (as
suppliers and users of funds) with their customers (corporate, retail, institutional and
public clients, etc.).
 Shariah Requirements Relating to the Validity of Contracts

 "Shari’ah compliant" means observing strictly to the permissible (halal) and abstaining from the prohibited (haraam) as commanded by God.

 There are several requirements for a valid contract according to Shariah/Islamic law i.e. i) subject matter ii) offer and acceptance, iii) Price
and iv) Delivery/Possession.

 Also, for a valid sale, it must be instant and absolute, and non-contingent.

 It means that the sale must be executed on spot.

 Moreover, non-contingency means that the execution of the contract must not be depended on the occurrence of certain event the occurrence
of which is doubtful.

 It means that the contract must be unconditional.

 The contract will wtill be valid if a reasonable condition is there that do not conflict with the contract. For instance, deliver the product at a certain place.

 There some conditions are acceptable (unreasonable conditions) that are in market practice (urf).
 Shariah Requirements Relating to the Valid
Contract

Valid Sale

Delivery or
Contract (Offer
Subject Matter Price Possession
and Acceptance)
(Qabza)
 Contract (Offer and
Acceptance)
For a valid Islamic contract which is with the reference
to an expression of both offer and acceptance:

a. Islamic law of contract recognizes both express

Express (In Past
Implied
contracts as well as what has been described as
Tense)
contract by conduct (implied).

b. However, Islamic law insists on the session of

Capacity to Contract
contract (majlis al-'aqd) in the sense that both the
offer and acceptance are to be jointly connected in
one single session without any unnatural gap.
  Quantified i.e. the unit of measuring the price
must be known.
 Specific/Certain i.e., the price must be known
Price
and certain. For example, selling at the price
of PKR 75 today and PKR 100 next day will
make the sale void.

Quantified Specific/Certain
  Physical: The seller must have the commodity
physically available for delivery at the time of
sale.
Delivery/Possession
 Constructive: Have the title and possession of
the asset but not available at the time of sale.

Physical Constructive
 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 but is not in the favor of any party
will not be void.
 Valid but Disliked (Makrooh) Transactions

 Those transactions which are disliked. The transaction will be makrooh if the transaction is complete
but in a disliked fashion.

For example,

1. When a third party intervenes to buy something which was under negotiation of sale between other
parties.

2. Sale after hoarding.

Void Sale

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

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

 There are defects which cause 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.
 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)

Under normal circumstances, neither the buyer nor the seller has the sole right to rescind the contract after its
execution.

However, it can occur:

 When parties decide to rescind the contract mutually (Iqala).

 When there is a material error in the contract, evidence of fraud, a lack of legal or mental capacity, or other
applicable circumstances.

 In case of return of the product (in the case of Iqala), the price will remain unchanged.

 When there is no impact of the recession (Iqala) on third party. It is treated as a new transaction as if a new contract
has been executed the parties rescinding the original contract.
 Some of the Islamic contracts in practice

1. Contract of exchange that primarily concern trading as well as buying and selling activities including their sub-divisions such as
cash sale (Musawamah), deferred payment sale (Murabahah), deferred delivery sale (Salam), sale on order (Istisna’a), sale of
debt, sale of currency, and so on.

2. Contract of security that deal with Kafalah (suretyship), Rahn (pledge) and Hawalah (transfer of debt).

3. Contract of partnership (Shirkah) such as the profit and loss sharing modes of Mudarabah and Musharakah.

4. Contract of safe custody (Amanah)

5. Contract of pertaining to utilization of usufruct such as Ijara (hire or lease), Waqf (endowment), Qard (loan of money).

6. Contracts of pertaining to do a work such as Wakalah and Ju’alah