Islamic Law of Contracts and Business Transactions

Sigit S.Wibowo

September 19th , 2008

Sigit S.Wibowo () Prog. Ekstensi Manajemen-FEUI September 19 th , 2008 1 / 25

Contents

1 Introduction
2 Māl (Wealth), Usufruct and Ownership
3 General Framework of Contracts
4 Elements of a Contract
5 Broad Rules for the Validity of Mu‘āmalāt
6 W‘adah (Promise) and Related Matters
7 Types of Contracts
8 Commutative and Noncommutative Contracts
9 Conditional or Contingent Contracts

Sigit S.Wibowo () Prog. Ekstensi Manajemen-FEUI September 19 th , 2008 2 / 25

Introduction

Islam considers the property of people as sacred and inviolable as

their life and honour
Islam forbids the unlawful devouring of others’property by way of
theft, embezzlement, usurpation, bribery, cheating and all other
unlawful means of acquiring wealth
These proscriptions are in addition to the main prohibitions like Riba,
Gharar and Qimār

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Māl (Wealth), Usufruct and Ownership

Contracts deal with goods/wealth (Māl), usufruct of goods and

transfer of ownership of the goods/usufruct from one to another party
Wealth is anything that is useable and has legal and material value for
the people
value
possessable
legitimate use
abstract and intangible rights
…duciary money (a medium of exchange)
Māl or property in Islamic commercial law
movable and immovable
fungible and nonfungible
…nally determinate (‘Ain) and indeterminate (Dayn)

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Māl (Wealth), Usufruct and Ownership (cont’d)

With respect to the exchange of goods, Islamic law distinguishes

between Mabi‘(the subject of sale) and Thaman (price)
Ownership can be any of the following categories of assets and can be
acquired through contracts, succession or addition to the existing
owned assets of someone
Ownership of assets (Milk ul‘Ain)!de…nite and not related to time
Ownership of debt (Milk ud Dayn)
Ownership of usufruct (Milk ul Manf‘at)!related to time
An important categorization of goods
fungible goods (Zwatul Amthāl or Mithli), e.g. Salam
nonfungible goods (Zwatul Qiyam or Qimi), e.g. Istisna’a
“Sale and buy-back” (Bai‘al ‘Inah) is prohibited according to the
majority of jurists, “sale and lease-back” is allowed by almost all

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De…ning Various Related Terms

Mithāq
A covenant and refers to an earnest and …rm determination on the part
of the concerned parties to ful…l the contractual obligations; it has
more sanctity than ordinary contracts
Ahd or W‘adah
a unilateral promise or an undertaking, although sometimes it also
covers a bilateral obligation
Aqd (Contract)
the existence of two parties; the issuance of an outward act depicting
internal willingness; an o¤er (Ijab) and acceptance (Qabul). Further,
there must be a legal union between the two declarations regarding the
subject matter or the contractual obligations
implies obligation arising out of a mutual agreement

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De…ning Various Related Terms (cont’d)

‘Aqd is used in two senses

in the general sense, it is applied to every act which is undertaken in
earnestness and with …rm determination, regardless of whether it
emerges from a unilateral intention or from a mutual agreement
in the speci…c sense, it is a combination of an o¤er (Ijab) and
acceptance (Qabul), which gives rise to certain legal consequences
Islamic law relating to business generally deals with ‘Ahd/W‘adah
(promise) and ‘Aqd (contract)
Islamic …nancial institutions presently enter into promises in respect of
a number of transactions, for instance:
Murabaha to Purchase Orderer
Ijarah Muntahia-bi-Tamleek
Sale and lease-back
Diminishing Musharakah
Disposal of goods purchased through Salam
Disposal of assets manufactured/constructed under Istisna‘a
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General Framework of Contracts

Islamic law is related to the methodology of the Shar¯¬’ah in dealing

with Ibādāt (devotional acts) and Mu‘āmalāt (transactions)
Ibādāt are held to be universal truths that are una¤ected by time and
space
Mu‘āmalāt are matters pertaining to individuals interacting among
themselves
Imam Ibn Taymiyah
“The acts and deeds of individuals are of two types: Ibādāt, whereby their religiousness is improved, and Adāt
or Mu‘āmalāt (transactions), which they need in their worldly matters. An inductive survey of the sources of the
Shar¯¬’ah establishes that devotional acts are sanctioned by express injunctions of the Shar¯¬’ah. Thus, what is not
commanded cannot be made obligatory. As regards transactions, the principle governing them would be
permissibility and absence of prohibition. So nothing can be prohibited unless it is proscribed by Allah (SWT)
and His Prophet (pbuh) in the overall framework."

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General Framework of Contracts (cont’d)

Mu‘āmalāt, in turn, pertains to two types of activities, i.e. social and

economic and/or …nancial
A basic rule of Islamic law: the apparent wording, any format or
writing of the contract
Only that will have legal consequences; any party who has entered
into a contract cannot say that it was not his intent (Niyyah)
The validity of the contract requires that its motivating and
underlying cause should be according to the requirements of the
Shar¯¬’ah

Sigit S.Wibowo () Prog. Ekstensi Manajemen-FEUI September 19 th , 2008 9 / 25

Elements of a Contracts

A contract comprises the following elements

they must be mature and sane
an o¤er (Ijab) and acceptance (Qabul)
a legal (Sharie) basis of union between the two declarations and the
contractual obligations
free from all prohibited factors
The contract is invalid if the following elements are not found
properly:
the form, i.e. o¤er and acceptance (Sighah)
the contracting parties (‘Aqidain)
the subject matter (Ma‘qud ‘alayh)

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Elements of a Contracts (cont’d)

There are seven components in a contract (Sanhuri)

the concurrence of o¤er and acceptance;
the unity of the Majlis (session/meeting) of a contract;
plurality of the contracting parties;
sanity or the power of distinction of the contracting parties;
subject matter susceptible to delivery;
the object (Mahall) de…ned;
the bene…cial nature of the object, in that trade in it is permitted as
per Shar¯¬’ah rules.

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Broad Rules for the Validity of Mu‘āmalāt

Free mutual consent

All transactions, in order to be valid and enforceable, must be based on
free mutual consent of the parties
Consent obtained through oppression, fraud and misperception renders
a contractinvalid as per Islamic law
Consenting parties have certain and de…nite knowledge of the subject
matter of the contract and the rights and the obligations arising from it
Prohibition of Gharar
All valid contracts must be free from excessive uncertainty (Gharar)
about the subject matter or the consideration (price) given in exchange
Avoiding Riba
Riba is an increase that has no corresponding consideration in an
exchange of an asset for another asset
Avoiding Qimār and Maisir (games of chance)
All contracts involving Qimār and Maisir are prohibited
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Broad Rules for the Validity of Mu‘āmalāt (cont’d)

Prohibition of two mutually contingent contracts

The sale of two articles in such a way that one who intends to purchase
an article is obliged to purchase the other also at any given price.
The sale of a single article for two prices when one of the prices is not
…nally stipulated at the time of the execution of the sale
Contingent sale.
Combining sale and lending in one contract
Conformity of contracts with the Maqasid of Shar¯¬’ah
The injunctions of the Shar¯¬’ah are directed towards the realization of
various objectives for the welfare of mankind
Pro…ts with liability
This principle states that a person is entitled to pro…t only when he
bears the risk of loss in business
Permissibility as a general rule
Everything that is not prohibited is permissible
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W‘adah (Promise) and Related Matters

In W‘adah or ‘Ahd, one party binds itself to do some action for the
other
’Ahd generally does not create legal obligation but in certain cases it
becomes legally binding and enforceable
Keeping in mind the intricacies of present-day business, particularly
when conducted by Islamic banks, contemporary scholars have
reached the consensus that W‘adah is enforceable by law until and
unless the promisor is not in a position to ful…l it on account of any
force majeure
If nonful…lment is due to any wilful act of the promisor, he has to
make good the loss to the promisee
The di¤erence between a contract (‘Aqd) and a bilateral promise is
that the ownership in bilateral promise is not transferred at the time
of signing the promise ‘Aqd, not only the ownership transfers but also
the rules of inheritance apply as soon as it is executed
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W‘adah (Promise) and Related Matters (cont’d)

The Islamic Fiqh Academy of the OIC has made the promise in
commercial dealings binding with the following conditions
The promise should be unilateral or one-sided
The promisor must have caused the promisee to incur some liabilities or
expenses
If the promise is to purchase something, the actual sale must take place
at the appointed time by the exchange of o¤er and acceptance. Mere
promise itself should not be taken as the actual sale
If the promisor backs out of his promise, the court may force him either
to purchase the commodity or pay actual damages to the seller. The
actual damages will include the actual monetary loss su¤ered by him,
but will not include the opportunity cost

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Token Money (Hamish Jiddiyah) and ‘Arbūn

Hamish Jiddiyah – the margin re‡ecting the …rm intention of the

promisee
Islamic banks take token money from the promisee clients, which is the
amount taken from them to convey seriousness in purchasing the
relevant commodity/asset
Banks hold token money as a trust and adjust it in price at the time of
the execution of the sale
‘Arbūn – the earnest money given at the time of execution of the sale
as part of the price
Taken from the buyer as part of the price after execution of the sale
agreement

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Types of Contracts

The Islamic Fiqh Academy of the OIC has made the promise in
commercial dealings binding with the following conditions
Valid (Sahih)
Voidable/defective (Fāsid)
Void (Batil)

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Valid Contracts

The validity of any contract depends on the legality or illegality of the

subject matter, the existence and precise determination of the subject
matter, delivery or the ability to deliver the subject matter without
involvement of excessive uncertainty and precise determination of the
price or consideration in a contract.
Contracts E¤ective Instantly or from a Future Date
Mawquf (Suspended) Contracts
Binding (Lāzim) and nonbinding Contracts

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Voidable (Fāsid) Contracts

Causes of invalidity are of two types

Intrinsic causes which relate to the basic elements of the contract, such
as unlawfulness or nonexistence of the subject matter, or the absence
of contractual capacity in any of the parties
Extrinsic causes that relate to Wasf, i.e. external attributes such as
Riba or Gharar contained in the contract.

Sigit S.Wibowo () Prog. Ekstensi Manajemen-FEUI September 19 th , 2008 19 / 25

Void (Batil) Contracts

Contracts that do not ful…l the conditions relating to o¤er and

acceptance, subject matter, consideration and possession or delivery,
or involve some illegal external attributes are considered void (Batil).
The sale of a thing having an element of absolute uncertainty or
speculation
A Batil contract does not give rise to any e¤ect

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Commutative Contracts (Uqood-e-Mu‘awadha)

Classi…cation according to object

Bai‘Muqayadhah (barter sale)
Bai‘al Hāl (simultaneous exchange of goods for money, spot sale)
Bai‘al Sarf (exchange of money or monetary units)
Bai‘Salam (sale with immediate payment and deferred delivery)
Bai‘Mu’ajjal (deferred payment sale, commonly known as a credit sale)
Bai‘Mutlaq (normal sale of goods for money, also called absolute sale)

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Commutative Contracts (cont’d)

Classi…cation according to subject

Bai‘Tawliyah (resale at cost price)
Bai‘Murabaha (resale at cost price plus pro…t – bargaining on pro…t
margin)
Bai‘Wadhi‘ah (resale with loss); The above three forms of sale are
termed Buyu’al Amanat or trust sales)
Bai‘Musawamah (sale without any reference to the original cost
price-bargaining on price)
Ijarah or the contract of hiring is divided into:
Ijarat al Ashkhas (rendering services)
Ijarat al Ashya (letting things)
Istisna‘a (contract of manufacturing)
Wakalah can be both commutative and noncommutative contracts

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Uqood Ghair Mu‘awadha (Tabarru‘) or Gratuitous
Contracts

The main feature of these contracts is the donation of property

The donor transfers ownership of any property to a party without
consideration. The following contracts fall under this category
Hibah (gift)
Wasiyyah (bequest)
Waqf (endowment)
Kafalah (guarantee)
’Āriyah (loan of usable item free of any charge)
Loan (Qard)
Hawalah (assignment of debt).

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Conditional or Contingent Contracts
As a general rule, conditional contracts are not valid
This, however, requires some detail and some conditions could be
acceptable, that is three types of stipulations/conditions
T‘aliq – conditions which suspend a contract to any future event.
Idafa – an extension that delays the beginning of any contract until a
future time.
Iqtiran (concomitance) that varies the terms of the contract
Valid conditions are those that con…rm the e¤ects attributed to
juridical acts by the Shar¯¬’ah and which are admitted explicitly by it,
such as the option of stipulation (Khiyar al-Shart) reserved for a party
to revoke or ratify a contract within speci…ed days
Such a condition is valid because the Shar¯¬’ah has sanctioned the
option of stipulation and the option of inspection (Khiyar al-Ru’yah)
The stipulation to sell on the condition that the seller will not hand
over the goods to the buyer unless he pays the price is also a valid
condition, because it stresses and con…rms the e¤ects of the contract
and realizes its objective
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Reference

Muhammad Ayub (2007), Understanding Islamic Finance. West

Sussex, U.K.: John Wiley & Sons Ltd. (Chapter 5)

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