Islamic Law of Contract
Legal meaning of contract (Aqd)
• A Knot
• To bind
Essential elements of contract
• Contracting parties
• The words of the contract (the contract itself)
• Object of contract
• Consideration
Contracting Parties
Age of majority
Sane
Words of contract (Conditions in a contract)
The form through which a contract can be executed
• Spoken word
• Written word
• Deed
Rules for Validity of Conditions in a Contract
There are 4 rules for judging the validity of conditions in a contract
1. A condition that is not against the contract is a valid condition
2. A condition that is
1. Against a contract,
2. In market practice
3. Not against the injunctions of Quran and Sunnah –
Is a valid condition
Rules for Validity of Conditions in a Contract
3. A condition that it
1. Against the Contract
2. Not in Market Practice
3. In favor of one of the parties
Is a Void condition
4. A condition that is
1. Against the Contract
2. Not in Market Practice
3. Not in favor of one of the parties
Is a Valid condition
Does a Void Condition invalidate a Contract ?
1. In Aqd-e-Muawada ?
– Yes
2. In Aqd-e-Ghair Muawada ?
– No, but the Condition itself becomes invalid
Object of contract
✓ Should be property
✓ Must have a value
✓ Can be owned
✓ Should not be under another’s right
✓Should be under the seller’s Title and Risk
Definition of “Property”
Maal-e-mutaqawwam
Consideration
✓ Should be quantified and specified
✓But not Under Aqd–e Ghair Muawada
Islamic Law is expressed not as a general theory of
contract but as a set of rules for various specific contracts
e.g. Law of sale, Lease, pledge
The closest thing to a general law of contract is the law of
sale
It is used by jurists as a prototype and analogy for
all other contracts.
Freedom of contract under modern commercial law
Modern contract law honors any commercial contract
between two parties
The question regarding Islamic Contract Law is
•‘How much freedom does Islamic law allow us in
deviating from well-prescribed rules of Shariah?’
•‘Can new types of contracts be created in Islamic law?’
•‘Can new types of stipulations be added to existing
contracts?’
•‘In the absence of a specific divine ruling, what should be
considered permissible and what not?’
According to Ibn Taymiyya
“The underlying principle in contracts is permissibility. Any
condition is prohibited only if there is an explicit text or a qiyas
(analogy) proving its prohibition”
Contemporary scholars voice strong support for Ibn e Taymiyya’s
position
That contracts are valid until shown to conflict with Quran
or Sunnah
This is the Difference between Ibadaat and Muamlaat
The few new contracts that did emerge in classical times
Arose not from scholarly research, but from custom or
practice
The scholars vetted these contracts by analogy to standard
contracts
While vetting modern Islamic finance and banking contracts
The scholars are mainly concerned with whether a term conflicts
with any basic Shariah principle
Types of contracts
Types of contracts
✓ Compensatory contracts (Aqd e Muawadah)
✓ Non Compensatory contracts
(Aqd e Ghair Muawadah)
Or, in other words -
Commercial and Non-commercial contracts
Types of contracts – Compensatory contracts
Compensatory contracts
Sale (Bai’) Sale has been dealt with much more extensively
in writings than other contracts
Sale is ‘Trasnsfer of ownership of a property for a fixed price’
Both counter-values present and delivered immediately
Titles to both counter-values transfer at the time of sale
Even if actual payment or delivery is delayed by a stipulation
Types of contracts – Compensatory contracts
Some types of sales have acquired their own names
Salam: Forward purchase
Requires full payment of price before the parties separate
Sarf: Currency exchange
Stringently regulated because of Riba rules
Both parties must exchange the currency during the session in
which the trading is concluded
Types of contracts – Compensatory contracts
Istisna Commissioned manufacture
Arbun Option contract
Buyer makes a non-refundable deposit against price
Getting the right to confirm or rescind the sale
Ijarah Sale of usufruct – both persons and property
For Hanafis, whose definition of property or Maal excludes usufruct, Ijara
is an exception to general rule
Both counter-values in these contracts must be specified precisely, else
gharar renders the contract invalid.
Non Compensatory contracts
Gift: (hiba) Before actual delivery, gift is revocable, and does not
transfer title
➢ Offer and acceptance or their implied substitutes are
still required
➢ A gift may be rescinded in certain circumstances
Loan Two types of loan exist, Ariya and Qard
Types of contracts – Non Compensatory contracts
Ariya Gift of use of a property which is not consumed by use
Like a gratuitous lease
Except obligations of the parties are regulated differently
e.g risk of loss is on the borrower
Types of contracts – Non Compensatory contracts
Qard Loan of fungibles, such as money
Repaid with goods of identical description, rather than the very goods loaned.
Riba rules require that it be free from any form of compensation
Even in kind or services
The Prophet declared it more meritorious than outright charity
In Qard, the ownership, not the usufruct, transfers
(Goods which are consumed cannot be given on Ariya, but on Qard)
➢ Lender may demand repayment at any time
➢ Borrower may repay any time
➢ Repayment is required in the exact quantity lent, regardless of market value
So how do we retain the market value of the amount lent???
Types of contracts – Non Compensatory contracts
Guarantee (Dhaman)
Making an additional person liable in addition to the original debtor
Since it is gratuitous, a relatively high degree of Gharar is tolerated
e.g. I guarantee whatever obligations my son incurs
Problems with modern guarantees
Guarantees, under Islamic law must be gratuitous
i.e. the Guarantor cannot charge a fee for giving the guarantee
He can only recover out-of-pocket expenses
➢But not even the opportunity cost of the capital frozen to guarantee the
obligation
➢Islamic banks therefore cannot charge Guarantee Commission
Types of contracts – Non Compensatory contracts
Deposit (Wadi’a)
Deposit is the gratuitous safekeeping of property
Out-of-pocket expenses may be charged
Use of deposit without depositor’s permission is not allowed
Accessory contracts
Agency (Wakalah)
Pledge (Rahan)
Types of contracts – accessory contracts
Agency (Wakala)
Agency can be either gratuitous or compensated
Chief weakness from the viewpoint of modern practice
It is revocable at will by either party
Even if the term of the contract is fixed
Types of contracts – accessory contracts
Pledge (Rahan)
It binds only upon delivery
Limitations on Rahan
1. The Creditor or his agent should take possession of the pledged
property
2. The pledgee has no right to use the property, except with the
pledgor’s permission.
And not in a Qard loan. (would become Riba)
3.Pledgee cannot sell the property without consent of pledgor or court
Notion is that property cannot be taken without the owner’s permission
Four concepts of Islamic Contract law important in
modern financial practice
The non-binding nature of many basic contracts
A dual scheme for allocating risk of loss
Prohibition of sale of debt for debt
Non-binding nature of the promise
The above principles derive not from revelations but from
the concepts of Riba and Gharar
1. Non Binding (Jaiz) versus Binding (Lazim)
Contracts are of two types
Non-binding or Revocable at will (Jaiz)
Binding and Irrevocable (Lazim)
Non Binding (Jaiz) versus Binding (Lazim)
Jaiz contracts
A Jaiz contract may be terminated even if the contract
declares itself Irrevocable
Or, fixes a minimum term
A Jaiz contract is so by its very nature
A contract may be Jaiz to both parties e.g.
Agency
Partnership
Deposit
Ariya
Non Binding (Jaiz) versus Binding (Lazim)
Jaiz to both parties until delivery
Gift
Pledge
Terminable by one party
Pledge (after delivery)
Guarantee
Non Binding (Jaiz) versus Binding (Lazim)
Lazim contracts
Sale
Lease
Non Binding (Jaiz) versus Binding (Lazim)
The fact that many contracts are Jaiz shows that under
Islamic law, the parties consent is the basis for legitimacy
A Jaiz contract requires more than just agreement at the
time of contracting
It requires continuing satisfaction of parties
Sale and other binding contracts are Immediate exchange of
title
And hence the issue of continuous consent does not arise
A dual scheme for allocating risk of loss
Risk of loss in Trust versus amanah
A party holds an asset either as
Trustee (Amin)
Guarantor (Damin)
Amin is not liable for loss, until occurring through breach
of trust
Damin bears the same risk of loss as an owner
Clue to understanding the difference
“Gain accompanies liability for loss”
If someone derives benefit from an object
They should bear the risk of the true owner
In Ariya, the borrower reaps benefit from the property
Should therefore also bear the risk of loss
Deposit and pledge do not permit the holding party to
derive benefit from asset
Hence holder does not bear the risk of loss
Amin is not liable for loss of Amanah
In Ijarah, the owner gets rent from the property
Hence bears the risk of loss
