Contracts in Islam
Contract in Islam is an engagement and agreement between two or more parties in a legally accepted, impactful and binding manner. Islamic commercial law consists of many different types of contracts to suit different needs and circumstances; the legal relationship in these contracts involves a bilateral declaration from which flow legal consequences with regard to the subject matter and the price. This constitutes the actual transactions that create liabilities and rights of the parties.
Contract, from an Islamic legal perspective is theoretically divided into two main classes, namely unilateral and bilateral contract. While the former comprise of a transaction in favour of the recipient such as Hadiah or Hibah, Ibra, Wasiyyat, Waqf and Qard, the latter is more bound to strict rulings and guideline since it requires the consent of both the parties to a contract. It covers all other permissible commercial transaction, such as contract of exchange that primarily concern trading, buying and selling activities, contract of Security that deal with Kafalah, Rahn and Hawalah, contract of partnership, contract of safe custody and contract of pertaining to do a work such as Wakalah and Ju’alah. Also what is normally tolerated in an unilateral contract would not necessarily be the case in bilateral contract.
This classification is not meant to be exhaustive because contracts could be classified in different categories with respect to their impact, effectiveness and validity.
With respect to validity, contracts are categorized as Valid, Void or Voidable. In fact, a contract would be deemed valid if all its elements are found in order and all conditions have been met and if it doesn’t imply prohibited activities such as Riba or Gharar. It would be void if one of its major conditions is not fulfilled. And it would be voidable, if conditions of lesser importance, such as specifications of the subject matter, are not fulfilled. Contracts that involve prohibited items or that are structured in a way that is illegal may in certain circumstances be rectified by removal of the objectionable clause to make the contract valid. However, the underlying principle in contracts, in Islamic commercial law, is permissibility and validity. Any contract or stipulation is prohibited and void only if there is an explicit rule in the Shari’ah proving its prohibition and voiding.
Contracts with respect to legality could be classified into five categories: prohibited (Haram), reprehensible (Makruh), indifferent (Mubah), meritorious (Mustahab) and obligatory (Wajib).
Contracts in Islam could also as be classified as commutative or non-commutative: In a commutative contract, one party could validly be remunerated or compensated in consideration of what is done or given; like sale, purchase and lease. Whereas, in a non-commutative contract, there is no return or compensation as it is the case for Qard, Hibah, Kafalah or Hawalah. Commutative contracts could be considered as void if they include any void condition. While non-commutative contracts do not become void because of a void condition such as Gharar; the void conditions itself become ineffective.
Although contracts in Islamic law of transactions are classified into different categories, the basic contract essentially requires the existence of two parties, mature and sane, which must be capable of entering into contracts; the existence of an offer and acceptance which have to be with free mutual consent; a subject matter that should be in principle legal, existing, valuable, usable, capable of ownership/title, capable of delivery/possession, specified and quantified and the seller must have its title and ownership; and lastly, the contract must be free from any prohibited activity and not contradict any statutory or common law rule.
Contract, from an Islamic legal perspective is theoretically divided into two main classes, namely unilateral and bilateral contract. While the former comprise of a transaction in favour of the recipient such as Hadiah or Hibah, Ibra, Wasiyyat, Waqf and Qard, the latter is more bound to strict rulings and guideline since it requires the consent of both the parties to a contract. It covers all other permissible commercial transaction, such as contract of exchange that primarily concern trading, buying and selling activities, contract of Security that deal with Kafalah, Rahn and Hawalah, contract of partnership, contract of safe custody and contract of pertaining to do a work such as Wakalah and Ju’alah. Also what is normally tolerated in an unilateral contract would not necessarily be the case in bilateral contract.
This classification is not meant to be exhaustive because contracts could be classified in different categories with respect to their impact, effectiveness and validity.
With respect to validity, contracts are categorized as Valid, Void or Voidable. In fact, a contract would be deemed valid if all its elements are found in order and all conditions have been met and if it doesn’t imply prohibited activities such as Riba or Gharar. It would be void if one of its major conditions is not fulfilled. And it would be voidable, if conditions of lesser importance, such as specifications of the subject matter, are not fulfilled. Contracts that involve prohibited items or that are structured in a way that is illegal may in certain circumstances be rectified by removal of the objectionable clause to make the contract valid. However, the underlying principle in contracts, in Islamic commercial law, is permissibility and validity. Any contract or stipulation is prohibited and void only if there is an explicit rule in the Shari’ah proving its prohibition and voiding.
Contracts with respect to legality could be classified into five categories: prohibited (Haram), reprehensible (Makruh), indifferent (Mubah), meritorious (Mustahab) and obligatory (Wajib).
Contracts in Islam could also as be classified as commutative or non-commutative: In a commutative contract, one party could validly be remunerated or compensated in consideration of what is done or given; like sale, purchase and lease. Whereas, in a non-commutative contract, there is no return or compensation as it is the case for Qard, Hibah, Kafalah or Hawalah. Commutative contracts could be considered as void if they include any void condition. While non-commutative contracts do not become void because of a void condition such as Gharar; the void conditions itself become ineffective.
Although contracts in Islamic law of transactions are classified into different categories, the basic contract essentially requires the existence of two parties, mature and sane, which must be capable of entering into contracts; the existence of an offer and acceptance which have to be with free mutual consent; a subject matter that should be in principle legal, existing, valuable, usable, capable of ownership/title, capable of delivery/possession, specified and quantified and the seller must have its title and ownership; and lastly, the contract must be free from any prohibited activity and not contradict any statutory or common law rule.
Permission of Bai' and prohibition of Riba
Trade has been a morally acceptable activity in all civilizations since the earliest times and all religions approved of it. In Islam, a great deal of emphasis has been placed on trade (or Bai’) as a recommendable source for the acquisition of wealth. However, Islam distinguishes any increase generated from Riba from the increase in one’s wealth as a result of trading. In fact, while both trading and Riba based activities generate return and increase in capital, the profit in Bai’ is permitted, and the increase Riba is forbidden. Therefore, the rules of trading should be identified to make trade transactions different from Riba-based transactions.
Trade in Islam covers sales on credit as well as sale for cash price. It also covers sale of a commodity to be delivered in future against price to be paid in cash, on the spot. While, Riba comes from the benefit that the debtor has to pay to the creditor along with the principal amount regardless whether this return is a fixed or a variable amount, not considering whether it should be paid in advance or on maturity, and even if it is a service received as a condition for loan. Therefore, there is a significant difference between the trade’s profit and Riba, since the former is the result of real investment and economic activity that creates value and in which the business risk is allocated more evenly among all involved parties. Whereas, in Riba-based operations reward is guaranteed to only one party and the business risk is not evenly shared.
For all this reason, Riba-based transactions do not fulfill an important Shari´ah principle that associates profit to business risk. and it doesn’t conform to the principle that the earning profit should be legitimized by engaging in a productive economic activity and thereby contributing to development of resources and society.
In addition, trade is subject to profits as well as losses. That implies that even the recovery of the capital invested in trade is not assured. A Riba-based transaction, on the other hand, ensures the recovery of capital and seeks a positive return. Also, Profits in trade are not predetermined as regards to their size, even in the case of a credit sale, unlike interest whose size is part of the contract. This is contradictory to the Shari’ah principle that stipulates that a definite return for example would be considered unfair and unlawful.
Trade in Islam covers sales on credit as well as sale for cash price. It also covers sale of a commodity to be delivered in future against price to be paid in cash, on the spot. While, Riba comes from the benefit that the debtor has to pay to the creditor along with the principal amount regardless whether this return is a fixed or a variable amount, not considering whether it should be paid in advance or on maturity, and even if it is a service received as a condition for loan. Therefore, there is a significant difference between the trade’s profit and Riba, since the former is the result of real investment and economic activity that creates value and in which the business risk is allocated more evenly among all involved parties. Whereas, in Riba-based operations reward is guaranteed to only one party and the business risk is not evenly shared.
For all this reason, Riba-based transactions do not fulfill an important Shari´ah principle that associates profit to business risk. and it doesn’t conform to the principle that the earning profit should be legitimized by engaging in a productive economic activity and thereby contributing to development of resources and society.
In addition, trade is subject to profits as well as losses. That implies that even the recovery of the capital invested in trade is not assured. A Riba-based transaction, on the other hand, ensures the recovery of capital and seeks a positive return. Also, Profits in trade are not predetermined as regards to their size, even in the case of a credit sale, unlike interest whose size is part of the contract. This is contradictory to the Shari’ah principle that stipulates that a definite return for example would be considered unfair and unlawful.
Exchange in Bai' vs Loan
The main contract of exchange in Islamic commercial law is the contract of Bai’. Bai’ involves an exchange of one thing with other; one thing being the subject matter and the other being the price. Transactions in Bai’ require the transfer of complete and instant ownership of the commodity at the time of sale/purchase and the transfer is irreversible once executed. In the case of loans, there is a temporary but complete transfer of ownership of the loan amount or the object, along with usufruct and the ownership of the commodity which is money is transferred for specified period and exactly its similar has to be paid back.
However, not all types of exchange’ contracts are necessarily permissible, as those which give rise to Riba are unanimously prohibited by Islamic law. As such, the contracts of interest-based loans are excluded from the definition of valid Bai´. For that reason, instead of dealing in Riba-based operations, Islamic banks undertake a number of transactions for conducting real sector business, by serving as intermediaries and getting a return in the form of trade profit, lease rentals or profit from partnership based operations.
In addition; in Islamic loan transactions, instead of loaning the buyer money to purchase the good, banks might buy the good itself from the seller, and resell it to the buyer at a profit, while allowing him to pay the bank in installments. Banks also provide financing facility on the basis of Mudarabah, Musharakah partnerships and create debt by way of trading and leasing operations to earn a profit; these financial transactions should be associated with productive economic activity.
However, not all types of exchange’ contracts are necessarily permissible, as those which give rise to Riba are unanimously prohibited by Islamic law. As such, the contracts of interest-based loans are excluded from the definition of valid Bai´. For that reason, instead of dealing in Riba-based operations, Islamic banks undertake a number of transactions for conducting real sector business, by serving as intermediaries and getting a return in the form of trade profit, lease rentals or profit from partnership based operations.
In addition; in Islamic loan transactions, instead of loaning the buyer money to purchase the good, banks might buy the good itself from the seller, and resell it to the buyer at a profit, while allowing him to pay the bank in installments. Banks also provide financing facility on the basis of Mudarabah, Musharakah partnerships and create debt by way of trading and leasing operations to earn a profit; these financial transactions should be associated with productive economic activity.
Options to rescind a contract of sale
A sale is an exchange of an asset for another or the exchange of an owned commodity for another in return for money or by barter. Both the buyer and seller may be given an option to cancel a transaction during a given period after conclusion of that transaction. This concept is known in the Shari´ah under the caption of Khiyar, meaning to exercise the option to rescind the sale or to finalise it. Such option stipulation can be reserved by either of the parties. This gives the party that is disadvantaged of the necessary facts and information at the time of entering into the contract, the option to cancel the contract within a specified period. Some have used Khiyar as the theoretical basis for modern day Islamic option products.
Although, all Muslim Jurists agreed about the validity of the concept of Khiyar, they differentiated between various types of options:
1. Khiyar-al-Shart: Any of the parties would have option to rescind the sale within an agreed period of time. If the buyer exercises this option, then the seller is required to refund the price, if taken. Even when a sale is duly concluded, it still may not be absolutely binding on the parties involved if the condition of option is stipulated in the contract.
2. Khiyar-e-Majlis: the parties have right to withdraw from a contract as long as the parties do not leave the place of contract.
3. Khiyar-e-Naqad: the seller has the right to cancel the contract if the buyer does not make payment at the specified date.
4. Khiyar al ´Aib: the buyer could dissolve the contract if one of the goods is found defective, the defect was not brought into notice by the seller at the time of contract and the defect caused visible decrease in value of the goods.
5. Khiyar al Ro’yat: the option of inspecting the goods and return them if they don’t concord to their specification in the contract.
6. Khiyar al Wasf: the parties have right to exercise this option in case of the absence of a desired quality in the sold or exchanged goods.
7. Khiyar al Ghabn: the buyer could cancel the sale if the seller has sold the goods at price far higher than the market price.
8. Khiyar al Tayin: the buyer can make a selection of goods out of the available stock in a stipulated period.
Although, all Muslim Jurists agreed about the validity of the concept of Khiyar, they differentiated between various types of options:
1. Khiyar-al-Shart: Any of the parties would have option to rescind the sale within an agreed period of time. If the buyer exercises this option, then the seller is required to refund the price, if taken. Even when a sale is duly concluded, it still may not be absolutely binding on the parties involved if the condition of option is stipulated in the contract.
2. Khiyar-e-Majlis: the parties have right to withdraw from a contract as long as the parties do not leave the place of contract.
3. Khiyar-e-Naqad: the seller has the right to cancel the contract if the buyer does not make payment at the specified date.
4. Khiyar al ´Aib: the buyer could dissolve the contract if one of the goods is found defective, the defect was not brought into notice by the seller at the time of contract and the defect caused visible decrease in value of the goods.
5. Khiyar al Ro’yat: the option of inspecting the goods and return them if they don’t concord to their specification in the contract.
6. Khiyar al Wasf: the parties have right to exercise this option in case of the absence of a desired quality in the sold or exchanged goods.
7. Khiyar al Ghabn: the buyer could cancel the sale if the seller has sold the goods at price far higher than the market price.
8. Khiyar al Tayin: the buyer can make a selection of goods out of the available stock in a stipulated period.
