4

Islamic Contracts

1 Fundamentals of Islamic Contracts

In this chapter we will observe about Islamic contracts in general. In the
previous chapter, we explored about riba and gharar; these two sets of
rules and principles cut across all the contracts in Islamic law. Contract is
the very essence of various transactions without which transactions are
void of legal significance. Islam encourages trade and commerce and it is
mentioned in many verses in the Quran. Islamic commercial law has laid
down fairly detailed rules leading to the formation of contract, the guid-
ing principle here is that there should not be any injustice to honest and
legitimate trade and business. Islamic contract law is not expressed as a
general theory of contract but states rules for various specific contracts
such as law of sales, lease, pledge, and so forth.
Islamic commercial law is known as fiqh-al-muamalat in an Islamic
legal term. It is an important law of branch, deals with issues of con-
tract and the legal affect(s) arising from contracts; be it a valid, void
or voidable contract respectively. Islamic contracts cover a variety of
dealings and transactions to meet the needs of the society. The first
article of the Majallah al-Ahkam al-‘Adliyyah (the civil code of the
Ottoman Empire) endorses the idea that man is social by nature and

© The Author(s) 2017 55

N. Alam et al., Islamic Finance,
https://doi.org/10.1007/978-3-319-66559-7_4
56 N. Alam et al.

that social life is essential to him, stating that ‘In view of the fact that man
is social by nature, he cannot live in solitude like other animals, but is
need of co-operation with his fellow men in order to promote an urban
society. Every person, however, seeks the things, which suit him, and is
vexed by any competition. As a result, it has been necessary to establish
laws to maintain order and justice’. This approach of the Majallah is sel-
dom found in the other compilations of law.
The Syariah law of contract is primarily based on three fundamental
principles:

• The principle of justice to ensure neither party to a contract may

exploit the other. Hence, the riba is strictly prohibited under the
Quran.
• The principle of transparency. Those concerned must share all avail-
able information. Withholding crucial information bearing on the
transaction could render the contract invalid. Also contracts involving
a high degree of gharar are strictly prohibited. The objective is to pre-
vent the transactions that lead to disputation and lack of trust.
• The principle of maslaha, meaning the common interest supported by
the spirit of the Syariah and not by a specific text. On the basis of
maslaha, a particular form of transaction may be exempted from a
general rule because it has been shown in common practice to facilitate
business.

1.1 Essential Elements of a Valid Contract

Contract (Aqd) in Syariah means a tie or knot binding two parties together.
The contract is a declaration of offer and acceptance made at the same time.
Islamic laws of contracts are developed through the work of Islamic jurists,
based on the principles mentioned in the Quran and the narrations from
the Prophet Muhammad. There are many verses in the Quran, which men-
tions of a number of contracts, and axioms of wide application in the area
of a contractual relationship. These include various commercial contracts
such as sale, hire, guarantee, security, and deposits.
 Islamic Contracts 57

Contracts are drawn to ensure the existence of clearly recognized

guidelines for all parties involved. They state the standings of all those
involved and the condition(s) of the transaction(s) that are to take place.
A contract in Islamic law consists of an agreement made between two or
more parties, and the basic elements are quite similar to those of English
common law:

1.1.1 Offer and Acceptance

An offer is a proposal to make a deal, and an acceptance is an acknowl-

edgment by the person to whom the offer was made that the offer is
accepted. In other words, an offer is an agreement that is made by one of
the parties to the contract, and acceptance is the statement that is made
by second party in response to the offer. For example, if one of the parties
says ‘I want to sell this house to you for RM 150,000’ and the other party
says, ‘I accept’, then what has been said by the seller is offer and the state-
ment made by the buyer is called acceptance.
The key conditions of offer and acceptance are listed below:

• It is necessary that the acceptance conforms to the offer in all its details.
If the offer contains any material change in, or addition to, the terms
of the original offer, it will not be accepted. A counteroffer is a new
offer in Islamic law.
• The offer and acceptance have to be executed in the same session. In the
event any party to the contract is missing, then the session lasts till the
knowledge of it reaches to the party through messenger and he replies
and communicates his acceptance to the offeror.
• Assent must be genuine as the person giving his consent may not be
mentally competent or he may be a person subjected to coercion or
under influence.
• Existence of the offer till the issuance of acceptance. An offer must remain
open until it is accepted, rejected, retracted, or has expired. A counter-
offer closes the original offer.
58 N. Alam et al.

1.1.2 Contract Subject Matter

As the subject matter of the contract, both the item and consideration,
Islamic law stresses on the following matters: lawfulness, existence, deliv-
erability, and precise determination. The jurist lays down the following
condition for subject matter:

• Lawfulness: The object must be lawful and should be permissible to

trade. It must be of legal value, which means its subject matter and
underlying clause must be lawful, and it must not be prohibited by
Islamic law, neither a nuisance to public order or morality.
• Existence: The parties to a contract must legally own the object. The
issue of existence presupposes that the object of a contract must be in
existence at the time of a contract. For example, to sell a fetus.
• Delivery: The object should be potentially capable of certain delivery
to the buyer at the time of the contract. Therefore, Syariah prohibits
the sale of a camel which has fled, a bird in the air, or a fish in water.
• Determination: The object should be something known to the parties.
It must be determined precisely as to its essence, its quantity, and its
value to avoid any kind of exploitation and future disputes,

In addition, as per majority of jurists, the object should be clean and

Halal. It should be permissible under Syariah.

1.1.3 Consideration

The consideration in the Islamic contract may consist of money, goods,

or services. It must be something, which is capable of being given and, in
the case of service, should be capable of being performed. It is the legal
benefit received by one person and the legal detriment imposed on the
other person. For example, the seller is selling a car for RM20,000. The
seller gives up the car and gets RM20,000; the buyer gives RM20,000
and gets the car.
For price consideration, Islamic law does not restrict it to a monetary
price, but it may be in the form of another commodity similar to barter
 Islamic Contracts 59

trade. The Islamic prohibition against uncertainty requires that the price
must be in existence and determined at the time of the contract. It must
not be fixed at a later date with reference to the market price, nor can it
be left open, whereby subject to determination by a third party. For
example, in contract of money exchange, the rules of riba should be
strictly adhered to avoid the contract being void.

1.1.4 Capacity of the Parties to Contract

The parties entering into a contract must be competent to make a con-

tract means the legal capacity to make a contract. In Islamic law, no per-
son can validly conclude a legal transaction without first having attained
physical and intellectual maturity that being the equivalent of majority.
To enjoy full capacity, a person, whether male or female, should attain
physical puberty and enjoy sound judgment known also as prudence in
his or her judgment. Islam does permit minors to get into agreement,
which are beneficial, but with the approval of the guardian.
The underlying principle is that usually an incompetent person will
make a contract without understanding that he is making a contract and
without realizing the consequences of his action. In Islamic law, a minor,
a person of unsound mind, an insolvent person, a person legally declared
a prodigal, an intoxicated person, or a person suffering from an illness
which leads to his or her death cannot enter into a binding contract.

1.1.5 Legality

Legal subject matter is required for a contract to be enforceable. The

Islamic law does not enforce contracts based on illegal activity and are not
permissible under Syariah. In other words, the purpose of the contract
must be legal in terms of the Syariah. Some of the contracts that are
strictly prohibited under Islamic legal provisions are listed below:

• Contracts in violation of the prohibition of Riba

• Contracts in violation of the prohibition of un-permissible good
• Contracts in violation of the prohibition of gharar, mayisir, and so on
60 N. Alam et al.

For example, a contract to grow grapes for winemaking would be void

because an element of un-permissible object (wine) exists in the contract
and will make the contract null and void.

1.2 Classification Based on Nature of Contract

Classification of contract according to the nature of contract is conceptu-

ally divided into three main categories, namely, unilateral contract, bilat-
eral contract, and quasi contract, as explained in the following picture
(Fig. 4.1):

1.2.1 Unilateral Contract

A unilateral contract is a form of promise made by one with an intention

and expectation that the other party to contract would accept it. This
contract is gratuitous in character and does not require the consent of the
recipient. In other words, a unilateral promise binds only the person who
makes it until it is accepted by others, and once it is accepted, both par-
ties are equally bound by the contract.
It is normally applicable in transaction like reward (Al-Jualah) in which
someone offers a particular reward to the world at large in return for the
delivery of a sought-after subject matter. In a contract of Al-Jualah, the
offeror is bound by the offer unilaterally until other parties accept it.
Once it is accepted, both parties are bound by their promises equally.
Unilateral contract comprises of transactions in favor of the recipient
such as gift (hibah), rebate on offset of the debt (Ibra), will (wasiyyat),
qard Hassan loan, and so on.

Classification Based on Nature of

Contract

Unilateral Bilateral Quasi

Contract Contract Contract

Fig. 4.1 Classification of contract according to nature of contract

 Islamic Contracts 61

In other words, unilateral contract is a binding promise that the offeror (a

person who makes a proposal) makes and is conditional upon the perfor-
mance by the offeree. For example, a person (offeror) approaches a real estate
agent and asks him to find a house for him for which he will pay him one
month’s rent as commission. The broker finds a house which the person agrees
to rent. The broker is entitled to his commission. The key here is that promise
by the offeror, is one sided type of contract because only the offeror, who
makes the promise, will be legally bound. The acceptance of the offer occurs
through performance by offeree (real estate agent) i.e. upon renting the house.

1.2.2 Bilateral Contract

A bilateral contract requires at least two parties, formally in which one

party should make a proposal and the other should accept. The mind of
both parties must coincide and the declaration must relate to the same
subject matter. The object of contract must be able to produce a legal and
beneficial result for both the contracting parties. The dominant idea of a
bilateral contract in Islamic law is that it establishes a legal relationship,
arising from the mutual consent of the minds of at least two parties in deal-
ing with each other, in respect of certain rights and obligations thereof.
For example, A sells his car to B for RM150,000 on cash basis. In this
case the former consents to pass his car to the latter, who consents to take
the car with an obligation to pay the price in cash.
The differentiation between bilateral or unilateral contract depends on
what the offeree must do to accept the offer and to bind the offeror to a
contract. If to bind the offeror, the offeree must only promise to perform,
the contract is a bilateral contract. Hence the bilateral contract is a prom-
ise for a promise. The contract comes into existence the moment the
promises are exchanged.

1.2.3 Quasi Contract

A quasi contract is not by nature a contract, but the implication gives rise
to an obligation similar to that of contract. A quasi contract is an obliga-
tion, which does not originate from a proper verbal agreement, as in law
of contract or tort. A quasi contract has little or no affinity with a contract,
62 N. Alam et al.

for example, an action to recover the money paid by mistake. If the inno-
cent party mistakenly interprets the facts, pays to another party a sum of
money which he does not really owe, the law being just will require the
wrongful receiver of the money to restore it. However, his obligation is
manifestly not based upon consent; therefore, this description of quasi
contractual liability emphasizes its remoteness from any genuine concept
of a contract.
To conclude here, in the quasi contract, the obligation is enforceable
by the Syariah principle, since it is a matter of restoring the rights of oth-
ers. The Islamic law sanctions this, because an appropriation could only
be recognized if something is exacted through a proper transaction with
a mutual consent.

1.3 Classification According to Legal Consequences

Classification of contract according to the legal consequences is illus-

trated in the following picture (Fig. 4.2):

1.3.1 Valid Contract (Sahih)

A valid contract is defined as a contract in which its essence and attributes

are according to the Syariah and which subsequently has a legal effect of
enforceability. In other words, a valid contract binds the contracting par-

Classification Based on Legal

Consequences

Valid Invalid Void Binding Enforceable Withheld

Contract Contract Contract Contract Contract Contract

( SAHIH ) ( FASID ) ( BATIL ) ( LAZIM ) ( NAFIDH ) ( MAWQUF )

Fig. 4.2 Classification of contract according to legal consequences

 Islamic Contracts 63

ties equally. In a broader sense, a valid contract is one that is legal both as
regards its asl and Waqf (origin and attributes) and is in compliance with
the Syariah requirement. For a valid contract, the following three condi-
tions should be met:

• All the elements required by law must be complete

• The additional conditions must be fulfilled
• The purpose of the contract and its subject matter must be in compli-
ance with the Syariah.

The nature of a valid contract is that there must be contracting parties

who have legal capacity and express their agreement in terms of a sound
ijab (offer) and qabul (acceptance) on a particular subject matter recog-
nized by the Syariah. In addition, for a contract to be valid, there must be
an exchange of valuable consideration with a sincere intention, required
from both parties, to create a legal relation.
To summarize a valid contract is when the offer and acceptance both
are sound and the subject matter is in compliance with the Syariah
requirement.

1.3.2 Invalid or Deficient Contract (Fasid)

An invalid contract is an agreement, which is lawful in its substance but

unlawful in its description. The substance of an agreement refers to the
offer, acceptance, and the subject matter. In other words, invalid con-
tracts have the essential elements but doesn’t fulfill all the necessary con-
ditions, for example, price of the subject matter. If an agreement of sale
for a definite article is concluded by proposal and acceptance but the
price is not settled, the agreement would be fasid.
The object of a contract should be fit or suitable for carrying out a trans-
action, that is, it should be executable or doable within the normal business
environment. The Syariah renders any such contract invalid in situations in
which it will be impossible to achieve the consideration for which the con-
tract was agreed. For example, If ‘A’ offers ‘B’ a certain amount of money to
bring him the moon and ‘B’ accepts the offer, the Syariah rules it out as a
valid contract since it will be impossible to carry it out.
64 N. Alam et al.

1.3.3 Void Contract (Batil)

A void contract is an agreement in which both its substance and descrip-

tions are not in compliance with Syariah. A void agreement is illegal in its
origin and attributes; in other words, the necessary elements and neces-
sary conditions are against the Islamic law. The Islamic jurists have a
unanimous opinion that anything, which is forbidden by Syariah, is not
tradable and hence cannot become the consideration or object of a con-
tract. As such, the contract will be void if A and B agree on a liquor deal.
In the same manner, there can be no valid contract for the sale and
purchase of stolen goods or delivery of inferior goods now at the promise
of returning superior merchandise later as it will constitute one kind of
riba or interest. Another example of a void contract is the agreement of
sale concluded by a lunatic, a minor, or a prodigal. Such contract is void
because it doesn’t fulfill the required substance of an agreement, in which
a sane, major, or sound-minded person must do the offer and acceptance.
To conclude a contract is a void contract when it is not valid, effective,
and enforceable, that is, opposite of valid contract.

1.3.4 Binding Contract (Lazim)

A binding contract is a sound contract without any defect either in its

substance or descriptions. A lazim contract can be further classified into
two based on the legal consequences:

• Irrevocable Contracts: An irrevocable lazim contracts are those where

the parties shall not have any right to revoke in any stage of the con-
tract, if such contract is concluded by mutual consent of the contract-
ing parties, for example, a contract of marriage or any other bilateral
contract. In the contract of a marriage, there is no revocation by either
party once it is concluded, except by a ‘Talaq’ pronounced by the
husband.
• Revocable Contract: Under revocable contract, the right to rescind can
be exercised by either party without the consent of other party. There
are two reasons due to which a contract becomes non-binding: nature
 Islamic Contracts 65

of contract and option. The nature of contract allows independence to

both parties like agency (Wakalah), partnership (sharikah), and several
others. Under option, an option is stipulated in the contract that pre-
vents it from becoming binding.

1.3.5 Enforceable Contract (Nafidh)

A nafidh contract is an agreement, which does not involve any right of

the third party. These contracts should not admit delays and must give
rise to its effect immediately.

1.3.6 Withheld Contract (Mawquf )

A Mawquf contract is an agreement in which the substance and the

description are lawful, but is concluded with the consent of a party who
does not own the subject matter of the contract. A Mawkuf contract as a
sale is dependent on the right of another like a contract of fuduli (fuduli
means the catalyst or someone who makes the disposition of property
without the consent of its owner or without the sanction of the Syariah).
Thus, the legal consequence of a Mawquf contract is pending or hanging,
until it is ratified by the owner on behalf of whom the fuduli concludes
the contract.

1.4 Islamic Sale Contract

The main contract of exchange in Islamic commercial law is the contract

of sale, and under this section, it will be covered in detail to understand
the practical aspects of theory mentioned under above sections. Islamic
banking activities are based on the trading principle of buying and selling
of assets. As such contract of sale plays a pivotal role in the Islamic
banking.
Sale (bai) is commonly defined in Syariah as ‘the exchange of a thing
of value by another thing of value with mutual consent’. In general sale
involves an exchange of a commodity for another commodity (barter
66 N. Alam et al.

trading) or of a commodity for money (sale) or of money for money

(sarf ). The golden principle in trading is that the contract should not
contain any element of riba, gharar, or maysir or else the contract is
deemed void or voidable according to the condition.

1.4.1 Classification of Sale Based on the Things Sold

The classification of sale based upon the things sold is categorized as listed
below:

• Sale of property to another person for a price and this is the most com-
mon category of sale.
• Sale by exchange of money for money is known as ‘sarf ’ transaction,
which consists of selling cash for cash.
• Sale by barter, that is, exchange of objects for object whereby no money
is involved; each of the two commodities constitute both the price and
the object.
• Sale by immediate payment against future delivery such as bay al-salam
(forward sale) and bay al-istisna (advance payment may or may not
applicable). The item of the sale is yet to exist in the future date. For
both contracts there is an exemption from the rule about the prohibi-
tion of sale of non-existent goods.
– Bay al Salam: This term refers to an advance payment for goods,
which are to be delivered later. This is an exception to the rule that
no sale can be affected unless the goods are in existence at the time
of sale with a condition that goods are defined and the date of deliv-
ery is fixed, for example, RM10,000 paid in advance for a car to be
delivered on the certain date.
– Bay al Istisna: This is a kind of sale where a commodity is transacted
before it comes into existence, in other words, to order a manufac-
turer to manufacture a specific commodity for the purchaser. The
rules to be observed are that the price is fixed with the consent of
the parties and that necessary specification of the commodity is
fully settled between them.
 Islamic Contracts 67

1.4.2 Classification of Sale Based on the Nature

of Profit-Sharing

Sale can be further classified based on the nature of profit agreed in the
contract as mentioned below:

• Musawamah: This is the most common form and known as spot sale.
The seller and buyer enter into an agreement for selling and buying of
goods. The goods are delivered at once and the price is also paid. In
other words, it is basically a sale by mutual consent completed and
concluded through negotiations between the seller and buyer in which
no reference is made to the original cost price. It is a ‘profit sale’ but the
actual cost price and the amount of the profit is unknown to the buyer
because the seller is not bound in musawamah sale to disclose the cost
price.
• Murabahah: This is commonly known as cost-plus profit. This is a sale
agreement whereby the seller purchases the goods desired by the buyer
and sells them at an agreed marked up price, the payment being settled
within an agreed time frame, either in installments or lump sum. The
important thing in this contract is that the buyer knows the profit
charged by the seller. In short, it is a cost-plus-profit sale in which the
seller expressly discloses the profit to the buyer. Because of the sharing
of cost and profit by the seller, the jurists have considered it as a sale
based on trust (amanah).
• Tawliyyah: This is a sale at the cost price without any profit for the
seller. This sale is again based on the principle of trust (amanah). The
contract appears to be a form of substitution contract where one party
who has bought goods no longer needs them and is willing to assign
the right to a third party.
• Wadiah: This sale takes place when the seller agrees to sell a commod-
ity at a lower price than that of the cost price. Since the seller is selling
the commodity at a lower price, it is also a trust sale. This form of
contract appears to be useful for a seller who is getting rid of his inven-
tories to improve his liquidity position, for example, departmental
store announcing sale based on wadiah for certain goods. It may serve
as a sale gimmick to increase sales of other goods.
68 N. Alam et al.

1.4.3 Possibilities of Payment Under Sales Contract

The possibilities of payment based on the sale contract are as mentioned

below:

• Cash Sale: Under this sale the purchaser is under obligation to settle
the purchase price agreed upon when concluding a contract. In the
event the buyer is not able to settle the payment, the seller has a right
to retain the goods sold until the buyer makes the payment.
• Deferred Payment Sale: Under this sale the amount is payable on install-
ment basis. This is permissible provided the period thereof is definitely
ascertained and fixed manner of payment is applicable to all types of
sales except in the case of bay al-salam. This principle is normally fol-
lowed for Bai Bithaman Ajil contracts.
• Lump Sum Payment: The lump sum amount is payable in the future.
This manner of payment is also permissible provided the date of pay-
ment is fixed in advance. This manner of payment is also applicable on
all the types of contract except bay al-salam.
• Earnest Money (al-arabun): The advance payment of partial amount of
total sale price is made to the seller which constitutes part of the pur-
chase price should the buyer decides to buy the good. Otherwise, the
seller forfeits the advance payment.

1.4.4 Essential Requirement for Sales Contract

In addition to the above general rules, the sales contract should have
essential elements and the necessary conditions as illustrated in the fol-
lowing picture (Fig. 4.3):

Contract: Offer and Acceptance

The term ‘offer’ means that one person proposes to either sell his com-
munity to another person or buy from him, and ‘acceptance’ means that
the person who has been offered gives his approval of the proposal.
 Islamic Contracts 69

VALID SALE CONTRACT

( BAI SAHIH)

PARTIES CONDITIONS
OFFER SUBJECT
ACCEPTANCE TO OF PRICE
MATTER
CONTRACT CONTRACT

• Oral • Oral • Major & Sane • Non Contingent • Existence • Quantified

Sale
• Written • Written • Legally Capable • Valuable • Specified &
- Unconditional
• Gesture • Gesture • No Coercion Contract • Permissible Certain
Exercised - Under
• Electronic • Delivery Reasonable • Ownership
Communication • Payment Condition
• Delivery
- Under
• Letter of Post Unreasonable • Specific Quantity
Condition
• Electronic • Object
• Sale must be
Communication Immediate Ownership

Fig. 4.3 Valid sale contract

Modes of Offer

(a) Orally: An offer can be made by words used for concluding a sale.
(b) Written: An offer could also be made by writing a deed, which will
have equal legal effect as the one made verbally.
(c) Gesture: An offer by gesture is valid if a person who is incapable of
making it either verbally or in writing makes it, for example, an offer
made by a handicapped, dumb, or deaf person.
(d) By post, telegram, telex, fax, phone, or by e-mail. All these instruments
convey offers made by words and writings.

Tense of Offer
An offer is generally made using past tense, but in some situations, an
offer could also be made in other tenses and manners. The offer may be
made by the aorist tense in which if it indicates a present tense then the
sale is valid but if it indicates a future tense (‘I will buy’, ‘I will sell’) then
the sale is invalid. In other words, an offer should be definite, absolute
and have a decisive language.
70 N. Alam et al.

Termination of an Offer
An offer could be terminated and will not have any legal effect under
the following circumstances:

(a) Revocation: If the offeror after making the offer at any time before it
is accepted changes his mind and revokes his offer, the latter will be
effective and the offer will be treated as terminated.
(b) Rejection by the Offeree: If an offer is not accepted and the offeree
rejects it, it will be treated as terminated.
(c) Counter Offer: An offer could also cease to have legal effect if it is
neither rejected nor ignored by the offeree but the offeree may accept
it with some additional condition in which the expression of the
offeree would be treated as counteroffer and it will eventually termi-
nate the original offer.
(d) Absence of Acceptance: An offer is made but no acceptance so far has
been received to it; hence the offer will be terminated.
(e) Death: If death of either the offeror or the offeree occurs before it is
accepted, the offer is terminated.
(f ) Lapse of Time: An offer is made with a condition that it should be
accepted within a specified period of time, and if the offeree fails to
accept within the prescribed time limit, the offer is considered
terminated.

Modes of Acceptance
An acceptance can be made in the following ways:

(a) Oral Acceptance: An acceptance may be made by words of mouth as

long as the offeror could understand it.
(b) Written: An acceptance may be made in writing in the same way as it
is made by words of mouth.
(c) Gesture: An agreement by implication or gesture is sufficient for the
acceptance of the offer. For example, a sale is concluded by gestures,
made by a dumb person.
(d) Delivery: A sale is concluded by an exchange being carried out, as that
is evidence of the mutual agreement of the two parties.
 Islamic Contracts 71

(e) Payment: An acceptance in a contract of sale could be presumed by

the payment made by the buyer in consideration of the subject
matter.
(f ) Letter of Post: A letter or message sent by post or messenger contain-
ing the message of acceptance may be substituted for a verbal and
personal communication in the contract of sale.
(g) Other Modes: Telex, e-mail, telegram, phone, fax, and other instan-
taneous method of legal communications are recognized by
Islamic jurisprudence as mode of acceptance to conclude a valid
contract.

Tense of Acceptance
An acceptance must be either in past tense or present tense for a valid
contract. In no situation, an acceptance can be made in future tense. This
shall make the contract null and void.

Contract: Parties to the Contract

The parties to the contract are buyer and seller and both should meet the
following eligibility criteria to get into a valid contract:

1. Parties to the contract must be sane and capable of taking responsibili-

ties. They should be major, reasonable persons and who possess
judgment.
2. The two parties to the contract must not be prohibited from dealing
with their property, that is, they must not be bankrupt or prodigals.
3. There is no coercion or compulsion exerted on either of the two par-
ties to the contract.

Contract: Conditions of Contract

• Sale Must Be Non-contingent

The delivery of the sold commodity to the buyer must be certain and
should not depend on a contingency or chance. For example, ‘A’ sells his
72 N. Alam et al.

car stolen by some anonymous person to ‘B’ who purchases it in the hope
that he will manage to recover it. This sale will be considered as void.

(a) Unconditional Contract: The sale must be unconditional, for exam-

ple, ‘A’ buys a car from ‘B’ with a condition that ‘B’ will employ
his son in his firm. The sale is conditional and hence invalid.
(b) Under Reasonable Conditions: I the conditions which do not go
against the contract, for example, ‘A’ tells ‘B’ to deliver the goods
within a month, the sale is valid.
(c) Under Unreasonable Condition But in Market Practice: If a sale is
under unreasonable condition but is in market practice, the sale is
considered as valid. For example, ‘A’ buys refrigerator from ‘B’
with a condition that ‘B’ undertakes its service for one year. The
condition being recognized as a part of the transaction is valid and
the sale is lawful.

• Sale Must Be Immediate: The sale must be instant and absolute.

Thus, a sale attributed to a future date or a sale contingent on a
future event is void. If the parties wish to effect a valid sale, they will
have to effect it afresh when the future date comes or the contin-
gency actually occurs. For example, ‘A’ says to ‘B’ on January 1 that
he will sell his car on February 1, the sale is void, because it is attrib-
uted to a future date.

Contract: The Subject Matter

The necessary conditions related with the subject matter to be taken care
in the contract are listed below:

1. Existence: The subject matter of sale must exist at the time of sale.
Thus, a thing, which does not exist, cannot be sold. If a non-existent
thing has been sold, even with mutual consent, the sale is void accord-
ing to the Syariah. For example, ‘A’ sells the unborn calf to ’B’, the sale
will be considered as void.
 Islamic Contracts 73

2. Valuable: The subject of sale must be a property of value. Thus, a thing

having no value according to the usage of trade, for example, a leaf or
a stone on roadside, cannot be sold or purchased.
3. Permissible: The subject of a sale should be permissible under the
Syariah, for example, trading in pork or liquor.
4. Ownership Can Be Transferred: The subject matter should not be any-
thing, which is not capable of ownership or title cannot be transferred,
for example, sea or sky.
5. Capable to Deliver: The thing should be capable of being delivered and
can be easily possessed. For example, an un-constructed building can-
not be possessed since it is non-existent.
6. Specific and Quantifies: The subject of sale must be specifically known
and identified either by pointing or by detailed specification that can
distinguish it from other things, which are not sold. For example, if ‘A’
owns a building and offers ‘B’ to buy an apartment and ‘B’ accepts the
offer, the sale is void unless the apartment is specifically identified and
pointed out to the buyer.
7. Object Ownership: The subject matter of sale must be in the ownership
of the seller at the time of sale. Thus, what the seller does not own
cannot be sold. If he sells something before acquiring its ownership
and risk, the sale is void. For example, ‘A’ sells a car to ‘B’, which is
presently not owned by ’A’. The sale is void because at the time of the
sale, ‘A’ did not own a car.

Contract: The Price

The necessary conditions related with price to be taken care in the con-
tract are listed below:

• Quantified: The measuring unit of the pricing should be known, for

example, currency and so on.
• Specified and Certain: A sale can be valid only if the price is ascertained
and specified. If the price is uncertain, then the sale is void. In other
words, currency and amount must be known and amount must be
absolute.
74 N. Alam et al.

1.5 Contracts in Islamic Banking

Islam permits trade and commerce and the contracts are applied thereto
are termed muamalat in the Syariah. Muamalat are civil contracts and
all civil contracts can be used in Islamic banking and finance. Thus, in
the concept of Islamic banking, the mobilization of deposits is through
contracts permissible by the Syariah, and the application of funds is
also through contracts permissible by Syariah. This can be further clas-
sified into three broad categories as illustrated in the following picture
(Fig. 4.4):

1.5.1 Trading Contracts

These contracts are based on the trading principle of buying and selling
of assets and play a pivotal role in the Islamic banking. Islamic banking
follows trading principle for financing the customer needs. The trading
contract can be for goods, cash, and debt trading as explained in the

ISLAMIC BANKING
CONTRACTS

Trading Participation Supporting

Contract Contract Contract

• Bai Murabahah • Musharakah • Rahnu

• Bai Tawliyah • Mudharabah • Kafalah
• Bai Wadhiah • Musa qat • Wakalah
• Bai Salam
• Muzarah • Qard Hassan
• Bai Istisna
• Hiwalah
• Bai Bithaman Ajil
• Bai Istijrar • Tabarru

• Bai Inah • Hibah

• Ijarah • Ibra

Fig. 4.4 Islamic banking contracts

 Islamic Contracts 75

Islamic sales contract. The most common trading contracts, which are
followed by Islamic Banks, are listed below:

1. Bai Murabahah (Cost Plus): It means a sale on mutually agreed profit.

Technically, it is a contract of sale in which the seller declares his cost
and the profit. Islamic banks have adopted this contract as a mode of
financing.
2. Bai Tawliyah: It means a sale at cost without any profit for the seller.
This sale is again based on the principle of trust (amanah).
3. Bai Wadhiah: This sale takes place when the seller agrees to sell a com-
modity at a lower price than that of the cost price. Since the seller is
selling the commodity at a lower price, it is also a trust sale.
4. Bai Salam: Salam means a contract in which advance payment is made
for goods to be delivered later on. The seller undertakes to supply
some specific goods to the buyer at a future date in exchange of an
advance price fully paid at the time of contract.
5. Bai Istisna (Sale by Order): It is a contractual agreement for manufac-
turing goods and commodities, allowing cash payment in advance and
future delivery or a future payment and future delivery. A manufac-
turer or builder agrees to produce or build a well-described good or
building at a given price on a given date in the future.
6. Bai Bithaman Ajil (Deferred Payment Sale): It refers to the sale of
goods on a deferred payment basis at a price that includes a profit
margin agreed upon by both buyer and seller.
7. Bai Istijrar (Supply or Wholesale Financing): It refers to an agreement
between the client and the supplier, whereby the supplier agrees to
supply a particular product on an ongoing basis, for example, monthly,
at an agreed price and on the basis of an agreed mode of payment.
8. Bai Inah: It refers to the selling of an asset by the bank to the customer
through deferred payments. At a later date, the bank will repurchase
the asset and pay the customer in cash terms. This is normally used for
offering overdraft facility to the customers.
9. Ijarah (Leasing): It refers to an arrangement under which the lessor
leases an equipment, building or other facility to a client at an agreed
rental against a fixed charge, as agreed by both parties.
76 N. Alam et al.

1.5.2 Participation Contracts

Islam encourages equity-based participation where stress is more on

profit- and loss-sharing. Bank/lender should invest their money to
become partners in business instead of becoming creditors. This encour-
ages entrepreneurship translated into banking terms; the depositor, the
bank, and the borrower should all share the risks and the rewards of
financing business ventures. The objective is that high-risk investments
provide a stimulus to the economy and encourage entrepreneurs to maxi-
mize their efforts. The most common participation contracts, which are
followed by Islamic banks are listed below:

1. Musharakah: Financing through equity participation is called

Musharakah. Two or more partners contribute to the capital and
expertise of an investment. Profits and losses are shared according to
the amounts of capital invested. This type of transaction has tradition-
ally been used to finance medium- and long-term investments. Banks
have the legal authority to participate in the management of the proj-
ect, including sitting on the board of directors.
2. Mudharabah: Under a Mudharabah contract, the bank provides the
capital needed for a project, while the entrepreneur offers labor and
expertise. The profits (or losses) from the project are shared between
the bank and the entrepreneur at a fixed ratio. Financial losses are
assumed entirely by the bank; the liability of entrepreneurs is limited
to their time and effort. In cases of proven negligence or mismanage-
ment by entrepreneurs, however, they may be held responsible for the
financial losses.
3. Musaqat: It is a specific type of Musharakah contract for orchards.
Musaqat is an arrangement between the farmer or garden owner and
the worker who undertakes to water the garden and so on and do all
such work, which would help the harvest or fruition. In this case the
harvest is shared among all the equity partners according to their
contributions.
4. Muzarah: It is essentially a Mudharabah contract in farming where the
bank can provide land or funds in return for a share of the harvest.
 Islamic Contracts 77

1.5.3 Supporting Contracts

There are other contracts in compliance with the Syariah that support
and facilitate trading and mobilization of capital. The most common
supporting contracts practiced by banks are listed below:

1. Rahnu (Mortgages): It is an activity whereby a valuable item is collater-

alized to a debt, which may be utilized as payment should the debt is
not repaid within the agreed period. In the event the debtor is not able
to repay the debt, the pawned asset will be sold off to settle the
outstanding debt and any surplus will be given back to the owner of
the asset.
2. Kafalah (Guarantee): Under this contract a third party becomes surety
for the payment of debt. It is a pledge given to a creditor that the
debtor will pay the debt, fine, and so on.
3. Wakalah (Agency): A contract of agency in which one person appoints
someone else to perform a certain task on his behalf, usually against a
certain fee.
4. Qard Hassan (Benevolent Loan): This is an interest-free loan. The bor-
rower is only required to repay the principal amount borrowed, but he
may pay an additional amount at his absolute discretion, as a token of
appreciation.
5. Hiwalah (Transfer of Debt): It means transfer; legally, it is an agree-
ment by which a debtor is freed from a debt by another becoming
responsible for it, or the transfer of a claim of a debt by shifting the
responsibility from one person to another—contract of assignment
of debt. It also refers to the document by which the transfer takes
place.
6. Tabarru (Donation): It is a donation/gift, the purpose of which is not
commercial but is for welfare or service in the name of God. Any ben-
efit that is given by a person to other without getting anything in
exchange is called Tabarru.
7. Hibah (Gift): It is basically a gift; normally on Islamic Saving Account,
the bank gives hibah as a token of appreciation to customers for keep-
ing their money with the bank.
78 N. Alam et al.

8. Ibra’ (Rebate): Ibra’ is in the form of a reduction in the balance out-

standing upon early settlement of financing amount and the compu-
tation will be based on the terms and condition agreed in the
contract.

In the following chapters, we shall be discussing in detail the financing

and investment contracts.

References
http://www.gulfnews.com/Articles/news.asp?ArticleID=101049
http://www.bnm.gov.my/index.php?ch=174&pg=469&ac=387
http://www.ambg.com.my/is_concepts.asp
Bakar, M. D. Contracts in Islamic commercial and their application in modern
Islamic financial system.
Billah, M. M. Modern financial transactions under Syariah.
Islamic Law of Contract. Retrieved from http://islamic-finance.net/siber/lib2/
law-2.html
Nyazee, I. A. K. Outlines of Islamic jurisprudence.
Sarker, M. A. A. Islamic business contracts, agency problem and the theory of
the Islamic firm. International Journal of Islamic Financial Services, 1(2).
Usmani, M. I. A. MEEZANBANK’s guide to Islamic banking.