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Islamic Commercial Law

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Islamic Commercial Law

Muhammad Yusuf Saleem

John Wiley & Sons Singapore Pte. Ltd.

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Copyright © 2013 by John Wiley & Sons Singapore Pte. Ltd.

Published by John Wiley & Sons Singapore Pte. Ltd., 1 Fusionopolis Walk, #07–01, Solaris South Tower, Singapore 138628

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In the Name of God, the Merciful, the Compassionate

Praise be to God, Lord of the Universes, Th e Gracious, the Merciful, Master of the Day of Judgement.

You alone we worship; You alone we implore for help. Guide us unto the straight path— Th e path of those whom You have blessed, Th ose who have not incurred Your displeasure, Th ose who have not gone astray. Amen Qur ’an, 1: 1–7

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Contents

Preface xi

List of Abbreviations xiii

Acknowledgments xv

Introduction: An Overview of Prohibited Elements 1

Usury (Riba) 2Ambiguities in a Contract (Gharar) 3Gambling (Maysir) 4Prohibited (Haram) Properties 5

1 The Contract of Sale (Bay’ ) 7

Introduction 8The Pillars of a Sale Contract 9Prohibited Sales and Practices 14Contentious Sales 19Chapter Questions 29Notes 30

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viii / CONTENTS

2 Types and Classifi cations of Sales 33

Introduction 34Trust Sales (Buyu’ al-amanah) 35Def erred Payment Sale (Bay’ Bi-thaman Aajil) 36Islamic Banks and a Sale Contract 37Future Commodity Sale (Bay’ al-Salam) 39Manufacturing Sale (Bay’al-Istisna’) 43Currency Exchange (Bay’ al-Sarf) 47Chapter Questions 49Notes 50

3 The Contracts of Employment and Lease (Ijarah), Borrowing (I’arah), and Reward (Ja’alah) 51

Introduction 52The Pillars of the Ijarah Contract 53The Contract of Borrowing Things (al-I’arah) 60The Contract of Reward for Service (al-Ja’alah) 61Chapter Questions 64Notes 65

4 The Contract of Agency (Wakalah) 67

Introduction 68The Pillars of an Agency (Wakalah) Contract 69The Types of Agency 70Agency in Sale 71Agency in Purchase 73The Effects and the Rights and Liabilities of the Contracting Parties 74An Agent Appointing Another Agent 75Unauthorised Agency (al-Fadhalah) 76Termination of an Agency 76Chapter Questions 77Notes 78

5 The Contract of Loan (al-Qard ) 79

Introduction 80Loan (Qard), Debt (Dayn), and Borrowing Things (I’arah) 81A Loan That Provides Conditional Benefi t to the Lender 82Waiting or Giving Time to a Borrower Is a Commendable Act 84Chapter Questions 84Notes 86

6 The Contract of Safekeeping (al-Wadi’ah) 87

Introduction 88The Pillars of Wadi’ah Contracts 89Relationship Between the Parties 89When Is the Depository Held Liable? 90

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CHAPTER 1: Contents / ix

Using Deposited Money for Investment 91Wadi’ah and Islamic Banks 92Termination of Wadi’ah 92The Differences Between the Contracts of Wadi’ah and Qard 93Chapter Questions 93Notes 94

7 Partnership (al-Sharikat) 95

Introduction 96Division of al-Sharikat 96Capital Partnerships (Sharikat al-Amwal) 98Management of Partnership (Sharikat al-’Inan) 101Partnership of Services (Sharikat al-a’mal) 101Partnership of Reputation or Creditworthiness (Sharikat al-Wujuh) 102Partnership (Sharikat al-’Inan/Musharakah) and Islamic Banks 104Dissolution of Partnership 106Chapter Questions 107Notes 109

8 Silent Partnership (Mudarabah/Qirad ) 111

Introduction 112Pillars of Mudarabah Contract 113The Status of Sahib al-mal and Mudarib 114Distribution of Profi t and Treatment of Losses 114Types of Mudarabah 115Personal Expenses of the Mudarib 116What the Mudarib Cannot Do 117Void Mudarabah 117Termination of Mudarabah 118The Differences Between Musharakah and Mudarabah 119Chapter Questions 119Notes 121

9 Pledge, Mortgage, or Pawn (al-Rahn) 123

Introduction 124The Pillars of Pledge (Rahn) 125The Use of the Pledge by the Pledgee 126Forfeiture of the Pledged Property 127Chapter Questions 128Notes 128

10 Guarantee (al-Kafalah) 129

Introduction 130Pillars of Kafalah 131The Effects of Kafalah 132Immediate, Conditional, and Suspended Kafalah 132

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x / CONTENTS

Types of Kafalah 132Charging a Fee for the Service of Guarantee 133Letter of Guarantee 134Termination of Kafalah 134Chapter Questions 135Notes 136

11 Transfer of Debt (al-Hawalah) 137

Introduction 138Pillars of Hawalah 140Types of Hawalah 140Transfer of Right (Hawalat al-Haqq) 141Bill of Exchange (Suftaja) 141Termination of Hawalah 142The Differences Between Hawalah and Kafalah 142The Difference Between Hawalah and the Sale of Debt (Bay’ al-Dayn) 143Chapter Questions 143Notes 144

12 The Contracts of Absolution (al-Ibra) and Set-Off (al-Muqassah) 145

Introduction 146The Subject-Matter of Ibra 146The Pillars of Ibra 147Types of Ibra 149The Effect of an Ibra 149The Differences Between Absolution (Ibra) and Gift (Hibah) 150The Contract of Set-Off (al-Muqassah) 150Classifi cation of Muqassah 150Chapter Questions 152Notes 153

Answers to True/False Questions 155

Bibliography 161

About the Author 165

Index 167

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Preface

Islamic commercial law is an important component of al-fi qhal-mu’amalat. Its fundamental prin-ciples are provided by the Qur’an and the Sunnah. In the light of these principles, Muslim jurists have provided in great detail scholarly works on each individual contract. Islamic contracts are seen as a means that provide various options in order to obtain permissible ( halal ) earnings. Earning in a permissible way is considered an act of worship (‘ ibadah) in Islam. Muslim jurists in their voluminous books on Islamic Fiqh have discussed together the rules pertaining to worship ( fi qh al-’ibadat ) and the rules pertaining to commerce and business ( fi qh al-mu’amalat ) and give them equal treatment and signifi cance. A chapter would discuss the pillars ( arkan ) and condi-tions ( shurut ) for prayer ( salat ), while the next chapter would discuss the pillars and conditions of sale ( bay’ ) or partnership ( musharakah ) contracts. Any discussion on a certain contract would take into account the prohibitions of usury ( riba ), ambiguity ( gharar ), gambling ( maysir ), and other unlawful practises. Th e holistic approach adopted by Muslim jurists would also relate dis-cussions on an individual contract to the objectives of Shari’ah , which further supplemented the already existing body of literature on Islamic commercial and fi nancial laws.

Islamic banking and fi nance is contract-based banking and fi nance. An Islamic bank has to establish Shari’ah -compliant contractual relationship with its customers both on deposit and fi nancing sides. Various Islamic contracts are also used in diff erent sukuk structures for raising funds and their subsequent use. Th e knowledge of Islamic contracts is therefore central to any commercial, business, and banking activity. Th us, there is a renewed and growing interest in the study of Islamic contracts. However, there is also an increasing tendency among both students and practitioners of Islamic banking and fi nance to study individual contracts and transactions with-out referring to their philosophical foundations and the objectives of Shari’ah. Th ere is a danger

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xii / PREFACE

that there would be a greater emphasis on procedural and legal formalities of contracts while their substance and the purposes for which they are intended may largely be ignored. Th is would be a departure from the holistic approach that characterised Islamic law of transactions for centuries.

Each individual contract has its own pillars and conditions. Pillars ( rukun , plural arkan ) refer to the main constituent element of a contract without which a contract is not complete. Generally, pillars of a contract include the parties to a contract, the subject matt er of a contract, and the off er and acceptance (which show the mutual consent of the parties). Th ere are also conditions for each pillar of a contract—for instance, conditions related to the parties to have the requisite legal capacity ( ahliyyah ), conditions related to the object of the contract to be well defi ned and known, or conditions related to the language of an off er and acceptance to be clear. Conditions in a contract are meant to avoid ambiguities ( gharar ), usury ( riba ), gambling ( maysir ), and other prohibited elements. One of the important functions of conditions is to protect both parties and to manage possible risk that may arise from the contract. We have discussed the pillars for each individual contract and its important conditions. Since conditions related to the legal capacity of the contracting parties are universally applicable to all contracts, in this book unless necessary I have not repeated them for each individual contract. Th e assumption is that the par-ties to a contract have the requisite legal capacity. Instead the focus is on other conditions that are unique to that individual contract.

Th is book developed during my years of teaching at the Kulliyyah of Economics and Management Sciences, International Islamic University Malaysia. I was motivated to write this book primarily by the shortage of English books on Islamic commercial and fi nancial transac-tions that would combine the theory with the practise. Th ere was a need for a textbook that would discuss Islamic contracts with a view to practise them and to avoid discussions on detailed issues that fi ll volumes in the available works of Fiqh. At the same time, the book should not only dis-cuss the form of individual transactions but also their substance and purposes. Th is book begins with an introductory discussion on the prohibited practises. Th e fi rst two chapters discuss the contract of sale and its various types. In the succeeding chapters other contracts are discussed. A chapter is devoted to a discussion on an individual contract. However, in certain chapters two or three contracts are combined due to their similarities. Th e book also uses diagrams to explain contractual relationships between the parties and where necessary discusses their applications. At the end of each chapter, true/false and short answer questions are provided to enable read-ers to evaluate their understanding of the various contracts. Answers to the true/false questions can be found at the end of the book. For the sake of accuracy and convenience I have provided both the Arabic origin and the English translations of the Qur’anic verses and ahadith (singular hadith ).

I take this opportunity to express my gratefulness to Allah (swt) for granting me the abil-ity, health, and patience to complete this work.

Muhammad Yusuf Saleem International Islamic University Malaysia

Kuala Lumpur Ramadhan 1433

July, 2012

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List of Abbreviations

swt Subhanahuwata’ala pbAbuh Peace and blessing of Allah be upon him. mAbpwh May Allah be pleased with him/her. mAbpwt May Allah be pleased with them.

Abbreviations

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Acknowledgments

I take this opportunity to thank the IIUM Institute of Islamic Banking and Finance (II i BF), who asked me to produce a textbook on Islamic commercial law. In particular, I acknowledge the support I have received from Prof. Datuk Dr. Mohd Azmi Omar, the former Dean of II i BF and the current Director General of Islamic Research and Training Institute (IRTI), Jeddah, Saudi Arabia. Th anks are also due to Prof. Dr. Khaliq Ahmad, Dean Kulliyyah of Economics and Management Sciences and my colleagues at the Department of Economics and the Kulliyyah of Economics and Management Sciences, International Islamic University Malaysia for their encouragement and support. I would also like to thank Emilie Herman, Senior Editorial Manager, and Stefan Skeen, Senior Production Editor at John Wiley & Sons, and the rest of the editorial staff for their helpful suggestions that added clarity to the book. Th is book benefi tt ed a great deal from the classroom discussions that I have had with my students at both the graduate and under-graduate levels over the years. Without their contributions and invaluable suggestions this book would have been incomplete. A work of this nature involves references to the primary sources of Fiqh , which are the Qur’an and the Sunnah , and the secondary sources, which are the volu-minous Fiqh books writt en by jurists of diff erent Fiqh schools. Th ese references are necessary in order to ensure that an opinion or a ruling is accurately att ributed to a particular jurist or Fiqh school. I would like to acknowledge that I have benefi tt ed from Dr. Wahbah al-Zuhaili ’s Financial Transactions in Islamic Jurisprudence as translated by Mahmoud A. El-Gamal and Sayyid Saabiq ’s Fiqh al-Sunnah. Th e author, however, is solely responsible for any errors which may be found in the book or for the views expressed.

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Introduction

An Overview of Prohibited Elements

Th e Qur’an and the Sunnah are the two main sources of Islamic commercial laws. It was revealed at a time when both Makkah and Medina were blooming commercial centers of Arabia. Th e Qur’an and the Sunnah did not totally abolish the pre-Islamic commercial practices. Th ey approved all those transactions that did not confl ict with the principles of Shari’ah ; corrected and modifi ed some other transactions by eliminating unjust and prohibited elements from them; and pro-hibited some other business practices that had usurious elements, or suff ered from gharar , and fraud. Th is approach towards commercial and business practices is characterised by its focus on the prohibition of specifi c practices rather than on the enumeration of permissible transactions. Th e approach led the Muslim jurists to conclude that in commercial transactions ( mu’amalat ) the principle is permissibility, whereas prohibition is an exception. Hence, every commercial transaction that is not specifi cally prohibited or does not contain prohibited elements is permis-sible. Th is has facilitated the adoption of commercial transactions that are customarily practised by the people and that do not go against the Shari’ah prohibitions. It also encourages innova-tion and creativity when new Shari’ah -compliant products could be engineered. Th is is in stark contrast to matt ers of worship ( ‘ibadat ), in which any innovation is considered heresy ( bid’ah ). Th e main practices that are prohibited are usury, ambiguity in contracts ( gharar ), gambling and games of chance ( maysir ), fraud, bribery, the use of false weights and measures, taking others’ property unlawfully, and transactions on prohibited ( haram ) things.

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2 / ISLAMIC COMMERCIAL LAW

Usury (Riba) Th e Qur’an and the ahadith have forbidden usury ( riba ) in the strongest terms. Th e Qur’an has warned that those who practise usury are at war with God and His Apostle. Th e word riba denotes increase, addition, or excess. Riba refers to a stipulated increase over and above the loan amount that a debtor agrees to pay to his creditor in relation to a specifi c period of time. Charging an extra amount for the time, irrespective of the outcome of the enterprise, is con-sidered injustice. Th e borrowed money would have to be invested and combined with eff orts, and there could be the possibilities of profi t and loss. Th e shares of fund owner and fund user should be tied and connected to the underlying economic activities. Th ey are entitled to receive a certain predetermined percentage of the actual profi t made by the investments. A fund pro-vider cannot claim a certain fi xed rate of interest irrespective of the performance of the invest-ment. Islamic law, therefore, recommends profi t-and-loss-sharing contracts. In contrast, in usury the return to the usurer is fi xed in advance. Th e usurer is guaranteed a certain cost for his fund irrespective of the actual outcome from the investment. Th is predetermination of return to the usurer ignores the economic realities on the ground and, therefore, introduces distortion into the market, particularly when we consider that the predetermined interest is added to the cost of production and the prices of goods.

Moreover, it is one of the objectives of Shari’ah that wealth should benefi t not only its owner, but also the other contracting party and the society as a whole. Th is is best achieved when the risks and rewards of investment are shared between the fund owner and its user. In contrast, usury only guarantees a certain predetermined rate of return to the fund owner and ignores its user. A needy person who borrows money for consumption purposes is required to pay back more than what he has borrowed, and a person who borrows capital for trade and business has to take the risk of loss in case the business fails. Th e capital provider is guar-anteed his capital plus interest and protected from losses. Th e risks of investments are entirely shift ed to the borrowers.

Some writers have diff erentiated between usury and interest on the ground that the for-mer involves loans for consumption, whereas the latt er involves loans for production. Interest, they argue, is an extra charge imposed on a debtor who borrows money for productive pur-poses such as investment, industry, and trade, whereas usury is an extra charge imposed on a debtor who borrows money for consumption such as his own personal day-to-day needs. Th ey argue that interest is a reasonable charge for the use of money employed in productive purposes, whereas usury is unjust and forbidden. Th is view, however, could not be maintained. A debtor who borrows money for investment, trade, and business may face one of four possible situa-tions: He may make enough profi t to pay the capital and interest and keep the balance. Second, it is also possible that he may make profi t enough to pay for the interest, whereas he may not get any share of the profi t. Th ird, there is the possibility that he may not earn any profi t, in which case he has to return the principal and pay the interest. Fourth, he may suff er losses. In these three out of four possible scenarios, the transaction is not fair to the borrower. Even in the fi rst example, the transaction is not fair to the lender, as it is possible that the borrower may keep a larger share

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