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Islamic Law of Contracts and Business Transactions by Dr

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1 Islamic Law of Contracts and Business Transactions by Dr
Islamic Law of Contracts and Business Transactions by Dr. Syed Zulfiqar Ali Shah

2 Summary of last lecture
Types of Contracts Valid Contracts Mawquf (Suspended) Contracts Binding (L¯azim) and nonbinding Contracts Voidable (F¯asid) Contracts Some Forms of Voidable Contracts Legal Status of the F¯asid (Voidable) Contract Void (Batil) Contracts Commutative and Non Commutative contracts Uqood-e-Mu‘awadha (Commutative Contracts) Uqood Ghair Mu‘awadha (Tabarru‘) or Gratuitous Contracts Legal Status of Commutative and Noncommutative Contracts

3 Plan of todays lecture Conditional or contingent contracts
Some Accessory Contracts Wakalah (Agency) Types of Wakalah Wakalatul Istism¯ar Tawarruq Use of Tawarruq for Liquidity Management Jualah Parties to Ju‘alah Subject Matter of Ju‘alah and Reward Execution of a Ju‘alah Contract Parallel Ju‘alah Contracts Practical Process in Ju‘alah by Islamic Banks Some Islamic Financial Products Based on Ju‘alah Bai Al ISTIJRAR (Supply Contract) Summary

As a general rule, conditional contracts are not valid. This, however, requires some detail and some conditions could be acceptable. We find discussion in the Fiqh literature on three types of stipulations/conditions: 1. T‘aliq – conditions which suspend a contract to any future event. 2. Idafa – an extension that delays the beginning of any contract until a future time. 3. Iqtiran (concomitance) that varies the terms of the contract. In all these cases the contract may or may not be void even if the condition is void. Various jurists differ with regard to the result of stipulation. Both Hanafis and Hanbalis allow some delay in beginning contracts like lease of agency (where property is transferred only over time) until any future event, but not for sale

As regards concomitant conditions, all schools consider whether the condition agrees to or is in conflict with the purpose of the contract. For example, a stipulation that the buyer pays the price or the seller transfers full title is a valid stipulation. They also approve the condition that the buyer will pay in certain coins/currency or provide a pledge as security. However, they do not approve a condition that the buyer will never resell the object. The conditions that pose problems are those by which any of the parties gets an additional benefit. Here, jurists differ but Ibn Taymiyah has taken a practical approach by rejecting only those conditions which are in contradiction with the Qur’¯an and Sunnah or the Ijma‘a, or which contradict the very object of the contract. As regards the overall view of different schools of thought, Hanbali jurists emphasize the supremacy of the discretion of contracting parties and allow every condition and stipulation as long as it does not contradict any text from the Qur’¯an or the Sunnah. The Hanafi, Sh¯afi’¯I and Maliki jurists divide conditions into valid, irregular and void.

Valid conditions are those that confirm the effects attributed to juridical acts by the Shar¯ı´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 specified days. Such a condition is valid because the Shar¯ı´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 confirms the effects of the contract and realizes its objective. A condition in aid of a contract is valid, like a sale with a condition that the vendor in the cash sale will have possession of the property when the price is paid, or a sale on condition that the buyer should pledge something to the vendor as security for the price. Similarly, any condition which is customary to embody in a contract will be upheld. If a F¯asid (invalid) condition is put into a contract that is otherwise valid, the condition will be void while the contract will be valid and enforceable, i.e. without regard to that condition

A condition which is not of advantage to either party is regarded as superfluous and cannot be enforced. A condition which is repugnant to a contract or transfer of ownership but is of advantage to one of the parties will make the transaction debauched if made an inseparable part of it. A void condition is any condition which directly infringes any rule of the Shar¯ı´ah, or inflicts harm on one of the two contracting parties or derogates from completion of the contract. We can therefore conclude our discussion on the subject of conditions in contracts by stating that a condition or stipulation which is not against the main purpose of the contract is a valid condition. Similarly, a condition which has become a normal practice in the market is not void provided it is not against any explicit injunctions of the Holy Qur’¯an or Sunnah. For example, a condition that the seller will provide five years’ guarantee and one year’s free service is not void, neither is the availability of a warranty against defective goods a problem. Similarly, conditions may be imposed in a sale regarding the service or repair of any manufactured item sold to a buyer. The parties can give each other an option to cancel a transaction during a given period after the conclusion of that transaction.

8 Some Accessory Contracts
Major contracts being used by Islamic financial institutions like Shirkah, Bai‘, Ijarah and similar contracts have been discussed separately in various classes. However, there are some ancillary contracts that are used as part of the major contracts or could be used under various modes. Out of these, two contracts, namely Wakalah (agency) and Ju‘alah (rendering a service against reward), are being discussed here. Tawarruq (monetization or generating cash through purchase/sale activity) basically carries the concept of Murabaha in one way or the other, but it has taken the form of a separate mode that Islamic banks use along with some other major modes. Hence, it is also being discussed here. Istijrar, a kind of repeat sale that could take place under some major modes, has been discussed briefly. Other subcontracts like Hawalah (assignment of debt), Kafalah (guarantee) and Bai‘ al Dayn (sale of debt) would be discussed in the relevant classes.

9 WAKALAH (AGENCY) The literal meaning of “Wakalah” is looking after, taking custody or application of skill or remedying on behalf of others. From this, the word “Tawkeel” is derived, which means to appoint someone to take charge of something, and also to delegate any job to any other person. Wakalah is also a responsibility. It is therefore necessary for a Wakil to discharge his responsibility in the way a trustee discharges his responsibility in the case of Am¯anah.

10 Types of Wakalah Wakil-bil-Kusoomah (to take up various disputes/cases on behalf of the principal); Wakil-bil-Taqazi al Dayn (receiving debt); Wakil-bil-Qabaza al Dayn (possession of debt); Wakil-bil-Bai‘ (agency for trading); Wakil-bil-Shira (agency for purchase). Agency or delegated authority is proved by the texts of the Shar¯ı´ah. The holy Prophet (pbuh) himself delegated the job of purchasing a goat for him to a Companion named ‘Urwah al Barqi. Similarly, the fourth Pious Caliph, Hadhrat Ali, and a number of other Companions (Gbpwth) delegated their business to others.

11 Types of Wakalah The subject matter of agency or the act to be performed by the agent should be known/defined. If the agency is for the purchase of a thing, the genus, kind, quality and other necessary attributes of the commodity to be bought should be mentioned. Agency is not permissible in acts prohibited in the Shar¯i’ah or acts of disobedience such as theft, usurpation of property or conducting Riba-based business.

12 An act to be carried out by an agent should be one that admits representation. Hence, appointment of an agent for an act such as prayer, fasting, giving evidence or for taking an oath is not permissible, because these acts should be performed by the principal himself. An eyewitness to an incident, for instance, is required to give testimony himself. He is not allowed to delegate this task to another person. Some of the acts for which the agency contract can be invoked include sale and purchase, letting and hiring, borrowing and lending, assignment of debt, guarantee, pledge, gifts, bailment, taking and making payments, marriage and divorce, litigation and relinquishment, admission and acknowledgement of rights.

13 An agency contract may be specific or general
An agency contract may be specific or general. A bank, for example, may appoint an agent to purchase some kinds of goods as and when asked by it. This will be a general agency contract. If a bank asks an agent to sell his particular asset at a given price or as per its instruction, it will be a specific agency contract. Even in a general contract, the nature of job to be undertaken has to be clearly defined to avoid any disputes. Delivery of the subject matter, claiming the price, exercise of the right of option of defect or inspection and returning goods in the case of reclaiming and similar rights and liabilities are attributed to the agent, who is responsible for making payment and receiving goods on behalf of the principal. He would demand the price from the purchaser in case of sale. The agent can be sued for not performing as per the agency agreement in the case of purchase or sale. However, there are certain contracts which are attributed explicitly to the principal, such as marriage, divorce and settlement of murder.

14 The agent must perform according to the instructions of the principal and exercise due care and skill. He cannot entrust the job to another person without the consent of the principal. He must also avoid conflicts of interest. Hence, for example, he cannot sell his own property to the principal without fully disclosing that it belongs to him. Agency could generate third party liabilities. Banks, while appointing an agent for the conduct of any business, should take care of this aspect to ensure that the agent performs the function in good faith and with due diligence, and the contract may contain a clause to make him liable in the case of negligence on his part. An action performed by an agent on behalf of the principal will be deemed an action by the principal. According to the preferred juristic view, particularly of Shafi‘is and Hanbalis, ownership of a commodity purchased by an agent for the principal will stand transferred from the seller to the principal, without first entering into the ownership of the agent.

15 Sometimes jobs are undertaken without the proper authority of the principal. Such an unauthorized person is termed Fuduli in Islamic jurisprudence. There are two opinions regarding the legal status of contracts concluded on behalf of another without proper authority. The preferred view is that these are valid subject to ratification by the principal. A Wakalah contract comes to an end by mutual agreement, unilateral termination, discharging of obligation, destruction of the subject matter or death or loss of legal capacity. A Wakalah contract is used by Islamic financial institutions in respect of almost all modes like Murabaha, Salam, Istisna‘a, Ijarah, Diminishing Musharakah and activities like L/C, payment and collection of bills, fund management and securitization. Wakalah may be both commutative and noncommutative. Islamic banks mostly do not pay a fee to their clients who purchase/sell goods on their behalf or perform other functions. However, banks normally charge fees for agency services rendered by them on behalf of their clients. Fund management on the basis of Wakalatul Istism¯ar is one such example, wherein banks charge a fixed fee remitting all profits/losses to the investors. We discuss this briefly below.

16 Wakalatul Istism¯ar Islamic financial institutions can manage funds of investors on the basis of Wakalatul Istism¯ar, meaning agency services for the management of the funds. For their services, banks can get a pre-agreed fee irrespective of the profit or loss on the relevant portfolio. This fee may be fixed in a lump sum or as a monthly or annual remuneration in percentage of the amount of investment or the net asset value of the fund. For example, it may be agreed that the management will get 2% or 3% of the net asset value of the fund at the end of every financial year. However, it is necessary to determine any one of the aforesaid methods before the launch of the fund. The practical means of doing this would be to disclose in the prospectus of the fund the basis on which the fees of the management will be paid. It is generally presumed that whoever subscribes to the fund agrees with the terms mentioned in the prospectus. Therefore, the manner of paying the management fee will be taken as agreed upon by all the subscribers.

17 TAWARRUQ Tawarruq means to buy on credit and sell at spot value with the objective of getting cash, meaning that the transaction is not the need of the buyer; he simply wants liquidity, which he gets by purchasing a commodity on credit and selling the same forthwith for cash. If he sells to any third party, it is acceptable from the Shar¯i‘ah point of view, but if he sells to the person from whom he purchased on credit, it is not Shar¯i‘ah compatible according to the majority view. Despite being a grey area, Tawarruq is being used by many Islamic banks for liquidity management and as a mode of financing, especially for personal financing and credit cards. In the traditional books of Islamic jurisprudence, Tawarruq has been discussed mainly by the Hanbali and Shafi‘e jurists; but they also differentiate it from Bai‘ al ‘Inah. The difference between ‘Inah and Tawarruq is that “Mutawarriq” (the person who acquires liquidity in this way) sells the commodity to a third party, while in ‘Inah, the buyer resells it to the same seller from whom he had bought the commodity with a difference in the sale and purchase price.

18 The Hanbali and Shafi‘e jurists generally allow Tawarruq
The Hanbali and Shafi‘e jurists generally allow Tawarruq. There are two versions reported from Imam Ahmad Ibn Hanbal about the permissibility of Tawarruq. The majority of the Hanbali jurists have preferred the version according to which Tawarruq is permissible. However, Ibn Taymiyah and Ibn Qayyim have held it as impermissible. Maliki jurists, who are very strict about ‘Inah, do not see a major problem in Tawarruq. They consider it a way to avoid Riba. Some Hanafi jurists of later days have held that Tawarruq is ‘Inah, and hence abominable. But the majority of the Hanafi jurists have preferred the view of Ibnul-Hummam that ‘Inah is restricted to a situation where the commodity is sold back to the person from whom it was purchased; if it is sold in the market, the transaction is valid and permissible. However, Qardal Hasan (lending money without interest) is more preferable. Thus, the preferred view in all the four schools of Islamic Fiqh is that Tawarruq is permissible. The AAOIFI has also taken up the view that if a commodity is sold back, either directly or indirectly (through any agent), to the original seller from whom it was purchased on a deferred payment basis, this will be invalid, while if the commodity is sold to a third party, it is acceptable in the Shar¯ı´ah.

19 This is the position with regard to the original concept of Tawarruq, but the ruling changes if the transaction is infiltrated by some other elements. If a bank purchases a commodity having brisk market and sells the same to the Mutawarriq, who sells it in the market, there is no Shar¯ı´ah problem. But, if the bank appoints the Mutawarriq its agent to purchase the commodity on its behalf and then to sell the same to himself, the transaction will not be valid, as the two transactions of purchase and sale are interdependent and the bank has not taken the possession and the business risk. However, if the bank appoints him as an agent only for the purchase of a commodity on behalf of the bank, then, once it is purchased, the bank itself sells it to him through a separate contract with proper offer and acceptance, the transaction is valid, but not advisable. If a Mutawarriq appoints the bank his agent to sell a commodity that he would purchase from the bank for Tawarruq in the market and this agency is stipulated in the contract of sale as a condition, the transaction is not valid. However, if the agency was not a condition in the sale contract and has been effected after unconditional sale, the transaction is valid, but even then not advisable.

20 If Tawarruq is carried out through the national or international commodity exchange, wherein only brokers are doing some agency services and the goods always remain where they were without transfer of ownership from the seller to the buyer, it is vulnerable to violation of Shar¯ı´ah rules one way or another, because a number of conditions of a valid sale may be lacking. Some Islamic banks are conducting Tawarruq by way of shares of joint stock companies, Ijarah Sukuk (of tangible assets and also of services) and even “bundles of assets”, comprising real assets as well as cash and receivables (the real assets being in the majority in the bundle). Despite permissibility on legal grounds, use of such financing on an extensive level needs to be avoided. The Shar¯ı´ah scholars and experts in Islamic finance advise that Tawarruq practice must be of limited use only for meeting unavoidable liquidity needs of the corporate sector. “For individual consumers it must be completely out of the Islamic banking practices,” says Monzer Kahf, a renowned scholar of Islamic economics and finance. Nejatullah Siddiqi has observed in this regard: “The client approaches the Islamic bank with a wish to have cash and a collateral and comes back with the desired cash after signing a number of papers”. This trend of wide and careless use of Tawarruq would create systemic risk for the nascent finance industry. However, if all the conditions of a valid sale are properly observed, the transaction may be valid, but even then its extensive use could be problematic.

21 Use of Tawarruq for Liquidity Management
Some Islamic banks use Tawarruq to place and obtain funds. It can give a fixed return to the banks and, hence, it is widely used as Commodity Murabaha or Shares Murabaha in the Middle East. Acceptable Tawarruq arrangements can be executed in the following manner: one bank (in need of funds) and another bank (intends to place funds) select any commodity/stocks which are liquid in nature (such as blue chip stocks); the surplus bank purchases the commodity on cash payment from the market; the deficit bank purchases it from the surplus bank on credit (Murabaha) and after taking delivery, sells it in the market at spot price. The Tawarruq process seems to be very simple. However, extreme care should be taken while undertaking such transactions and it should be ensured that the transaction does not become a mere exchange of papers between two brokers and one or two banks. Islamic banks need to understand that Tawarruq arrangements should be used in extreme cases where no option is available to avoid interest. Widespread use of such products is harmful to the Islamic banking industry in the long run. Shar¯ı´ah boards need to strictly monitor all Tawarruq-based transactions.

22 JU‘ALAH Ju‘alah is a contract in which one party (the J¯a‘il) undertakes to give a specific reward (the Jua‘l) to anyone who may be able to realize a specific or uncertain required result, for example, finding a stolen car. Ju‘alah is permissible on the authority of the Holy Qur’¯an and the Sunnah. There is reference in Surah Yousuf to the announcement about the lost beaker of the King that the person who would find the beaker of the King would be given reward of a camel load grain. As regards the Sunnah, the holy Prophet (pbuh) approved a deal by some Companions who stipulated that if the Chief of the tribe was cured, they would be given compensation for that. Although some jurists restrict Ju‘alah to a reward for the return of a runaway slave, the majority of them consider it permissible for a number of activities. The determination of the required end result of the transaction is considered to be sufficient to make it permissible. Ju‘alah is a relevant and useful transaction in events that cannot be accomplished through Ijarah, such as bringing back a lost property from an uncertain location, because the Ijarah contract requires that the work must be specified. Accordingly, Ju‘alah may be used by Islamic banks for recovery of overdue debts and certain other services whereby the subject of the required work cannot be minutely specified.

23 Parties to Ju‘alah The two parties of Ju‘alah are the offeror and the worker; the former offers specified compensation to anyone (the worker) who has to realize a determined result in a known or unknown period. The worker may be any specified person(s) or the general public. In this respect also, it is different from Ijarah. Realization of the end result is necessary in Ju‘alah for payment of the compensation to the worker(s). In other words, if the worker, despite his effort, is unable to realize the objective, he will not be entitled to any compensation for his effort or time spent. Therefore, Ju‘alah is not affected by the uncertainty with respect to the subject matter or the work to be done. This is why it is suitable for activities for which Ijarah is not. It is not a condition of Ju‘alah that the worker be specified and it is sufficient that an offer is issued to the general public, in response to which any person can undertake the work himself or with the help of others. However, if any worker is specified, then he himself will have to undertake the work or he can involve others with the express consent of the offeror. Ju‘alah is similar to agency, in which seeking help from others is valid.

24 Ju‘alah per se is not a binding contract
Ju‘alah per se is not a binding contract. Parties in a Ju‘alah contract are entitled to terminate the contract unilaterally. However, when the worker commences the work, it becomes binding and if the offeror revokes in between, he will have to give a reasonable wage to the worker. The basis for the entitlement of the worker to receive reasonable wages when the contract is revoked after commencement of work is that the work done by the worker is legally valid and loss is not to be caused to him. When the parties undertake not to terminate the contract within a specified period, they must observe such an undertaking. If the worker himself revokes the contract after commencing the work, he has no claim against the offeror, unless they had agreed to the contrary. The worker is considered a trustee as to the property of the offeror in his possession. As such, he is not liable for any loss except in the case of negligence, misconduct or violation of the stipulated conditions.

25 Subject Matter of Ju‘alah and Reward
The subject matter of Ju‘alah is the work required to be done and the compensation agreed for the work. As Ju‘alah is a contract of exchange, it is necessary to indicate a task and the reward. The task should not be a legal or an employment obligation upon the worker and must involve some effort. The reward should be known and valuable, i.e. is permissible consideration, and deliverable when required, so as to avoid any uncertainty when the result is realized. The reward can also be a certain portion of the realized result. If the work to be realized is determined, a Ju‘alah contract is valid, despite uncertainty about the amount of work to be put in by the worker and the possibility of realization of the result. Ju‘alah can be used for undertaking various activities like extraction of minerals, finding any lost asset or property, collection of debts, getting any information for the benefit of the offeror, such as presenting a report on any subject or the project or undertaking any scientific invention, etc.

26 For example, governments may ask some firms for extraction of minerals with the condition that a specified amount of money will be given only to those who find any agreed-upon mineral with specified features. Ju‘alah can also be used for collection of due but defaulted debts, where the entitlement to compensation is contingent upon collection of agreed upondebts/ receivables. Compensation in this case can also be related to the amount of realized debts on a proportionate basis. For innovations, scientific discoveries and designs such as trademarks, the entitlement to compensation is contingent upon realization of the discovery or the accomplishment of the stipulated job. If Ju‘alah is used for brokerage activities, the entitlement to compensation will be contingent upon completion or execution of the contract for which the brokerage service has been sought. An offeror can specify a time for accomplishment of a job, after which the worker will not be entitled to any reward except any stipulation or adjustment otherwise. For example, parties can agree that if work on the job is at an advanced stage but remains incomplete due to any genuine problem, the completion time may be increased with mutual consent.

27 Execution of a Ju‘alah Contract
Ju‘alah can be concluded by an open or informal offer to the public. In this case, any person who hears or receives the offer and is interested to do the job may do so, either himself or through the assistance of another person. However, if a Ju‘alah contract is concluded with a specified worker, such a worker is obliged to perform the work himself. Conclusion of a Ju‘alah contract does not require a counter acceptance by another party (as is required in Ijarah), because the requirement of counter acceptance in Ju‘alah is practically unattainable, except when it is concluded with a specific worker who is obliged to perform the work himself.

28 As against Ijarah/Ujrah, the claim to the reward is not enforceable until the completion of the required work. (In Ujrah, the worker who had agreed to work for a stipulated time is entitled to a wage if he has worked for the settled time, irrespective of the work being completed or not.) However, the worker is entitled to the reward prior to the completion of the work in the following situations: 1. When it is found that the worker has worked to realize a result in respect of a property that does not belong to the offeror and a legal decision to that effect has been issued. 2. When an accident that was not due to the negligence or misconduct of the worker causes impairment of the value of the subject matter of the contract; here, the worker is entitled to the full reward. The worker is not entitled to a reward if Ju‘alah is terminated unilaterally by either party before the commencement of work. However, when the contract is terminated by the offeror after the work is commenced, the former is obliged to pay to the worker the common market remuneration.

29 Parallel Ju‘alah Contracts
A bank, after taking work, can get it done by others on the basis of a Parallel Ju‘alah. The two contracts will be independent of each other. The bank may play the role of the worker by signing a Ju‘alah contract. It may carry out the work itself or through another parallel contract with a third party, provided the first Ju‘alah contract does not require it to do the work itself. It is also possible for the bank to play the role of the offeror for performance, irrespective of whether it needs the work for its own benefit or for the fulfilment of its obligation in a Parallel Ju‘alah contract, taking into account that the two contracts remain independent.

30 Practical Process in Ju‘alah by Islamic Banks
Ju‘alah can be used by Islamic banks for a number of services, directly or through a Parallel Ju‘alah contract with the following process: The customer negotiates with the bank for performance of uncertain work in a specified time for an agreed reward. The bank agrees to perform the work after conducting a cost versus benefit analysis, and a Ju‘alah contract is entered into between the bank and the customer. The bank finds a worker with the expertise to perform such uncertain work on his behalf and a Parallel Ju‘alah contract is made with him. The work is completed by the worker and an agreed wage or reward is paid to him by the bank. The bank collects its reward from the customer with whom the initial Ju‘alah contract had been entered into. Similarly, banks can take services from others on the basis of Ju‘alah. Recovery of nonperforming debts is one such example.

31 Practical Process in Ju‘alah by Islamic Banks

32 Some Islamic Financial Products Based on Ju‘alah
Collection of Debts Ju‘alah contracts can be used for collecting due debts where the entitlement to the reward is related to realization of all or part of the debt. For example, a Ju‘alah contract for recovery of debt is entered into between “A Bank” and “B Ltd”. The contract provides for the reward as a percentage of the amount collected on the basis of Ju‘alah. The reward can also be paid in advance in full or in part, before completion of the work. However, in such a case, the worker shall not be absolutely entitled to reward until the required result is realized and the payment shall be made “on account” to him.

33 Some Islamic Financial Products Based on Ju‘alah
Securing Permissible Financing Facility Ju‘alah contracts can be used to secure permissible financing, in which a worker is required to do some form of service, like preparing of feasibility, that will make the bank agree to provide the facility to the offeror. Brokerage Ju‘alah contracts may also be used in brokerage activities, where entitlement to reward is attached to the signing of a contract which is intermediated by the broker.

34 Thank You

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