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Commercial Law
Within the context of providing Muslims with guidance about the commands of Allah, jurists devote a large portion of their works of fiqh to commercial law. Broadly speaking, the chapters of commercial law focus on defining the types of property that may be legally owned, the rights and obligations that attach to contracts and property, the modalities of transferring ownership of property, the methods of organizing resources and commercial ventures, and the analysis of ribā and gharar, which are7 usually translated respectively as “interest” and “risk.” The premodern works of fiqh reflect their savior ways that jurists synthesize these topics in order to articulate their visions of an Islamic commercial system and society.
Types Of Property And Notions Of Value
Jurists employ a number of conceptual systems in order to discuss notions of property and value. The Ḥanafī al-Sarakhsī (d. 1090) distinguishes between property that has financial value (māl mutaqawwim) and that which does not (māl ghayr mutaqawwim). More broadly speaking, jurists from the other schools distinguish between types of property whose sale are illicit and those whose sale are licit. This legal distinction depends on issues of ritual purity (najāsa), utility (manfaʿa), and the identity of the owner. For example, jurists prohibit the sale of impure goods like wine, carrion, pigs, and idols. Nevertheless, according to al-Sarakhsī, a Muslim is liable for damages to these goods if they belong to dhimmīs, for whom these goods have value. Another example is the sale of dogs, animals that most Muslim jurists consider ritually impure. However, al-Shīrāzī (d. 1083), a Shāfiʿī, argues that Muslims may own dogs that they use for beneficial purposes like herding and hunting.
For property whose sale is licit, jurists distinguish between ʿayn, manfaʿa, and dayn. ʿAyn is tangible property, but jurists also use this term to refer to gold or silver coins. Manfaʿa is the usufruct of a good or the labor of some person or animal. Dayn, on the other hand, is a[ debt that is the dhimmah (obligation) of the debtor. Jurists also differentiate between property which is manqūl (movable) and that which is ʿaqar (immovable). Finally, they contrast mithlī (fungible [goods contracted for without an individual specimen being specified] goods) to qīmī (non-fungible goods) in their discussions of damages and ribā.
Commercial Rights And Obligations
Jurists distinguish between contacts that are lāzim (binding) and those that are jāʾiz (non-binding). With a binding contract, the counter-party must perform on the contract or be legally liable. Some examples of binding contracts are sales, leases, and contracts of hire. On the other hand, with non-binding contracts like partnerships, agency relations, and non-interest-bearing loans, either one or both of the counter-parties may revoke the contract without penalty.
Islamic law also defines two types of relationships that counter-parties have with respect to property. The first, ḍamān (guarantee or liability), makes the guarantor liable for loss of or damage to the property. This relationship arises from the non-performance of a binding contract, a tort, or when a third party provides kafālah (surety) for a debtor. In cases of torts, the guarantor must replace the damaged or lost fungible good with the same good. With a non-fungible good, he must pay only the value of the good. By virtue of this guarantee, the guarantor is entitled to the profits of the property.
The second type, amānah (fiduciary relationship or trust), arises when someone holds a deposit or collateral, or acts as an agent, to name a few examples. The amīn (trustee) is not liable for the accidental damage or loss of the property unless he commits a tort, such as using the property without the permission of the owner.
Sales
Broadly speaking, there are two types of contracts that transfer ownership of property. The first transfers ownership without compensation, such as with gifts and dowries. The second is the muʿāwaḍa, or contract of mutual exchange. With this type of contract, the counter-parties may aim to profit (such as with bayʿs, or sales), provide assistance (as with a qarḍ, or interest-free loan), or do both of these (as with sharikah, partnerships). Below, we will focus on this second type of contract and start with the different bayʿs, which play a central role in commerce.
According to the Mālikī Ibn Rushd al-Ḥafīd (d. 1198), a sale occurs when two parties exchange property with each other. Depending on whether the property is ʿayn (tangible property) or dhimmah (debt obligation), transactions may theoretically occur according to one of the following ways: ʿayn for ʿayn, ʿayn for dhimmah, or dhimmah for dhimma.” In addition, each good can either be delivered immediately (nājiz) or later (nasīʾa), so there are a total of eight types of sales. 1wwHowever, not all of these combinations are licit. Jurists prohibit forward contracts in which both counter-parties sell on dhimmah for delivery at a later date.The Ḥanbalī Ibn Qudāma (d. 1223) states that a sale requires an ījāb (offer) by the seller and qabūl (acceptance) by the buyer during a majlis (bargaining session). According to a ḥadīth, “Both counter-parties of a sale have an option until they separate unless it is sale with an option.” The Ḥanbalīs and Shāfiʿīs agree that this ḥadīth means that a sale becomes final only once the counter-parties physically separate from each other. On the other hand, al-Bājī (d. 1081), a Mālikī, argues that the phrase “until they separate” means that a sale becomes binding only after the offer and acceptance.
Ibn Rushd al-Ḥafīd notes that the term “sale” actually refers to a variety of transactions. In its most basic form, a sale is the immediate exchange of a mathmūn (good) for thaman (money), or one good for another. However, depending on the nature of the goods of the sale and timing of their exchange, each type of sale may have a different technical name and some particular rules that govern it. For example, a ṣarf (currency exchange) is the exchange of money for money, which must be conducted with no delay in the exchange because of the prohibition against ribā.
Below, we will examine some other types of sales that were not only important for premodern commerce, but also continue to play a central role in contemporary Islamic finance.
As indicated in Ibn Rushd al-Ḥafīd’s typology, a sale may occur either with both of the counter-parties delivering the goods immediately, or with one of them delaying the delivery in what is called a salam. In Western finance, this contract is a derivative that is called a prepaid forward contract. According to Ibn Rushd al-Jadd (d. 1126), this contract has a long counter-party (ṣāḥib al-salam), who gives the prepayment (raʾs māl) immediately in exchange for the good (muslam ʿalayhi) that the short counter-party (muslam ilayhi) delivers later. This contract can be reversed so that a good is purchased on credit in what is called a bayʿ al-ajal (credit sale).
For a salam to be valid among the Mālikīs, it must fulfill the following five stipulations:
(1) The short counter-party must guarantee the good;
(2) The good must be accurately described and likely to exist at the delivery date;
(3) This good must be defined by its common unit of measurement;
(4) The long counter-party cannot delay the delivery of the prepayment beyond three days; and,
(5) The time period between the prepayment and delivery of the good must be long enough for its price to change.
Both counter-parties are thus exposed to market risk in order to prevent a risk-less arbitrage. On the other hand, the Shāfiʿīs argue that a salam that is due almost immediately is licit since it has less gharar (risk) than longer-dated contracts. According to Ibn Rushd al-Jadd, this contract is licit for the sale of food, slaves, animals, and fungible goods. However, he forbids it with immovable property, illicit goods like wine and pork, and transactions that violate the bans on gharar and ribā, which will be examined later.
In the premodern era, the salam contract was probably used to finance trade and the production of crops. However, it also functions as a means to hedge or speculate on the future price of a good. In fact, early Mālikī jurists are keenly aware of the ways that the salam can be combined with other transactions in order to replicate prohibited contracts like interest-bearing loans and forward contracts.
Murābaḥa
The murābaḥa is the sale of a good at the seller’s original cost plus an agreed-upon profit. With this contract, the seller explicitly states how much he paid to acquire the good. The counter-parties then agree upon either a particular sum of money or the profit margin that the seller will receive on his capital. Implicitly, the contract has an aspect of agency embedded within it, since the buyer must trust the claims of the seller. Generally, jurists state that this contract is permissible since it protects purchasers from predatory pricing practices. Legal discussions of this contract thus focus on defining:
- The costs and changes to the good that may be counted among the invested capital of the seller: and,
- The legal consequences if the seller is incorrect or lies about this amount.
Khiyār
A previously-cited ḥadīth indicates that a sale may occur with a khiyār (option) to invalidate the sale at a later time. With the exception of the Ẓāhirīs, who prohibit this option because it involves excessive gharar, the other schools permit it for either one or both of the counter-parties of a sale. An option, however, raises two central issues. The first is to define the maximum length of time before the option expires. The Shāfiʿīs and one Ḥanafī opinion limit this period in all cases to three days. Other Ḥanafīs and the Ḥanbalīs allow an option for any length of time that the counter-parties stipulate in the contract. Finally, the Mālikīs argue that the maximum lifetime until expiration of an option depends upon the good. An option for a dress can be only for three days, but a month for a house. The rationale is that more expensive and complicated goods require a longer time to be examined. The second issue that an option raises is who is liable for any damage to the good before the option expires or is exercised. Each school has a different view that depends upon who has the option, how the object was damaged, and the school’s general notions about liability.
Ījārah
An ījārah refers to both a lease and a contract of hire. With this contract, a party purchases the manfaʿa (usufruct) of a good or the labor of a person or animal. Generally speaking, this contract is illicit with goods whose sales or use are illicit, but there are some notable exceptions to this general rule. For example, one cannot sell a free person into slavery, but one can sell the labor of a free person with this contract.
This contract presents a conceptual challenge for the legal and financial analysis of many jurists. Although jurists often state that this contract is the sale of usufruct, the ījārah does not fit into the typology of sales that Ibn Rushd al-Ḥafīd outlined. Jurists thus disagree about whether the ījārah is a sale, or a different type of contract entirely. This disagreement arises from the fact that, unlike wheat or gold, usufruct is not tangible and, depending on one’s view, it does not exist when the contract is made. In fact, al-Sarakhsī puts this dilemma in the strongest of terms when he compares usufruct to an ʿaraḍ (accident) that inheres in a jawhar (essence). Like accidents, usufruct fades in and out of existence from moment to moment. In accordance with this conception of usufruct, he argues that it is extremely difficult to compare and value it. Notwithstanding these challenges, all jurists recognize the necessity of this contract and try to allay any concerns about potential gharar (illicit risk). For example, Ibn Rushd al-Ḥafīd argues that there is no risk as long as there is at least a fifty percent chance that the contract can be honored. Other jurists argue that the good or laborer stands in for the usufruct when the contract is made, so that in a sense the usufruct exists. To further reduce the potential uncertainty of this contract, jurists require that the usufruct be defined in terms of either the task that must be completed or the length of time that the lessee can enjoy the usufruct.
Finally, for some jurists, the usufruct and payment raise concerns about ribā, gharar, and other banned transactions. For example, al-Shīrāzī prohibits an ījārah in which both the payment and performance of the contract are delayed, because in his view this is analogous to an illicit forward contract.
Agency, Partnership, And Muḍāraba
Islamic law recognizes several different relationships that people may form to mobilize capital, labor, and technical skills for commercial ventures. The first, wakālah (agency), allows merchants to create formal relationships in order to conduct commerce. It also provides the legal basis for the mushārakat al-ʿaqd (contractual partnerships), as we will see. An agent can contract marriages, give testimony, perform communal religious obligations, and conduct different types of commercial transactions on behalf of the principal. The agent is a trustee for the principal unless he violates his fiduciary responsibilities. Ibn Rushd al-Ḥafīd distinguishes between agents who have unlimited authority and those who have limited authority.
Islamic law also recognizes four different types of partnerships. In contemporary Western law, partnerships are often distinguished as limited and unlimited based upon the liabilities of the partners. However, this distinction is not helpful in the context of Islamic law, since Islamic partnerships all have unlimited liability. Rather, Muslim jurists distinguish between partnerships on the basis of the sources of the funds and their possible uses.
With the ʿinān partnership, the partners combine capital, mutually guarantee all liabilities that arise within the partnership, and make each partner an agent for the others. The capital of the partnership is, however, limited to the common fund. According to the Shāfiʿīs and Mālikīs, the profits and losses of each partner must be in proportion to the capital that he or she invested. The Ḥanafīs, on the other hand, permit the distribution of the profits and losses in any proportion that the partners agreed upon when they formed the partnership.
The mufāwaḍa, which in its strongest form is associated with the Ḥanafīs, is the second type of partnership. Unlike the ʿinān, the mufāwaḍa, according to the Ḥanafīs, requires the partners to combine all of their money within the partnership. Each partner As a result of these two stipulations, the Ḥanafīs require the partners to be social, religious, and financial equals. Unlike the Ḥanafīs, the Mālikīs do not require the partners to contribute all of their money to this partnership or to be equals. On the other hand, the Shāfiʿīs prohibit this partnership because of the excessive gharar that arises from these guarantees.
With the abdān partnership, the partners contribute only their labor to the partnership. For the Mālikīs, this partnership requires agency and may include the mutual surety. For example, when this partnership is between craftsmen, each partner is an agent and surety for the liabilities that arise within the partnership. However, if this partnership is between hunters it does not require mutual surety. The Ḥanafīs allow this partnership only between craftsmen, whereas the Shāfiʿīs prohibit this type of partnership entirely, on the basis of their doctrine that all partnerships require tangible capital.
With the partnership of wujūh, the partners do not contribute any capital, but instead borrow to finance trade. The Ḥanafīs allow this form of partnership, but both the Mālikīs and Shāfiʿīs prohibit it on the grounds of excessive gharar since there is no equity to absorb any losses.
Finally, with the muḍāraba, an investor invests capital with someone who provides only his labor and expertise in exchange for a pre-agreed portion of any profits. The investor bears all of the losses unless the worker, who is a trustee, commits a tort. However, the investor is only liable for debts to the extent of the invested capital. Although the muḍāraba has some of the aspects of the partnerships we examined above, it is not a partnership and jurists do not discuss it in the chapter about partnerships.
Ribā
Undoubtedly the most conspicuous feature of Islamic commercial law is the ban on ribā. This term is generally translated as “interest” or “usury.” However, these translations obscure the polyvalent nature of this term and the different transactions to which it refers.
The word ribā occurs in several verse of the Qurʾān. According to Qurʾān 2:275, “Allah made trade lawful but prohibited ribā.” This verse also states that those who conduct transactions that contain ribā will be punished for this in the afterlife. Qurʾān 3:130 states, “Do not devour ribā, doubled and redoubled.” According to Ibn Rushd al-Jadd, this verse refers to the pre-Islamic practice of a creditor extending the maturity of the loan in exchange for doubling the balance. In addition to these Qurʾānic verses, jurists often base their discussions about ribā on the ḥadīth:
“Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt in equal measures and for immediate
Ribā al-faḍl, or ribā of excess, occurs when one purchases one of the aforementioned commodities with the same commodity and the qexchange occurs immediately but in unequal quantities. For example, one cannot trade a gold vase that weighs an ounce for two ounces of gold ore. Obviously, this transaction is not a conventional interest-bearing loan as the typical translation of the term ribā as “interest” implies. Rather, the difference in the total quantities of gold exchanged in this transaction reflects the fact that the craftsmanship of a vase has a value that exceeds that of an ounce of gold ore.
The ḥadīth also indicates that the timing of delivery of the goods affects the legality of these transactions. Ribā al-nasīʾa, or ribā of delay, occurs when one of the (1) if one purchases one of the aforementioned commodities with a greater amount of it, which is delivered at a later date, or (2) if one purchases one type of precious metal today for payment with another type in the future. The first transaction is clearly a conventional interest-bearing loan, and the second is structurally analogous to a salam of different precious metals. Based on other versions of this ḥadīth, some jurists also require that any exchange of a foodstuff for a different foodstuff also be completed immediately.
The ḥadīth mentions only six commodities, but with the exception of Ẓāhirīs, who prohibit the use of qiyās, the other schools apply this prohibition to other goods. The Ḥanafīs extend it to all goods that are sold by measure or weight, because of the fact that the precious metals listed in the ḥadīth are sold by weight and the other goods e[are sold by measure. The Shāfiʿīs and Mālikīs distinguish between the precious metals in the ḥadīth as forms of money and the other goods as food. Based on this distinction, the Shāfiʿīs extend the prohibition to all food and beverages, but the Mālikīs extend it only to food that is stored, is either nourishment or a condiment, and is a dietary staple for most people. In addition, the Mālikī Ibn Rushd al-Jadd argues that if two goods have the same name but sell for different prices at the same place and time, they are considered different goods and the prohibition does not apply to them. Ibn Ḥanbal has three views on this topic. The first is identical to the Ḥanafī view, the second to the Shāfiʿī view, and the third is a compromise that applies the ban to food that is sold by weight or measure.
It would be incorrect to assume that jurists banned these transactions out of financial naiveté. Their writings reveal a nuanced understanding of the time value of money, the importance of credit, and the financial needs of people. Muslim jurists and scholars of Islam have suggested a number of theories to explain the prohibition of ribā, but none of these explanations is comprehensive. For example, Ibn Rushd al-Ḥafīd argues that the ban on ribā al-faḍl protects counter-parties from fraud by forcing them to use money to exchange goods of the same type. In essence, he argues that, by using money, the counter-parties are sure to receive the prevailing market prices for their goods. However, it is not clear why, if people cannot value similar goods without cash, they are allowed to exchange totally different goods without the use of cash. Furthermore, the use of cash does not necessarily imply that one will not be defrauded.
Frank Vogel and Samuel Hayes explain the ban on the basis of the risks and rewards of the prohibited transactions. They cite a ḥadīth that states, “Gain accompanies liability.” They suggest that jurists prohibited ribā al-nasīʾa because, contractually, the creditor is not exposed to any risk with an interest-bearing loan. They argue that jurists approve of profits only when one bears the risks associated with ownership and future profitability. Furthermore, they note that loans are typically in consumable assets like money or food, which do not directly yield anything. This reasoning, however, ignores the fact that jurists are aware of, and permit, the credit and market risks that creditors face.
Hiroyuki Yanagihashi explains this prohibition from a historical perspective. He suggests that originally ribā applied to interest on loans as the Qurʾān implies, but jurists expanded the scope of this ban over time and in a piecemeal fashion. He argues that the regulations regarding gold and silver exchanges developed in response to Umayyad monetary reforms and interventions. The regulations on ribā al-nasīʾa developed in response to the credit risk associated with these transactions and modalities of compensating creditors in cases of bankruptcy. Finally, jurists prohibited ribā al-faḍl with food in order to ensure a more equitable distribution of the risks and rewards of sharecropping in favor of the worker.
Gharar
In our discussion of the salam, options, and ījārah, we saw that some jurists invoke the concept of gharar to explain their positions. Generally speaking, scholars of Islam and practitioners of Islamic finance translate this term as “risk” or “uncertainty.” The ambiguity of the translation of this term reflects the fact that gharar is an epistemological issue that arises from jahālah, or uncertainty. According to jurists, transactions with excessive gharar are illicit. However, if every form of uncertainty caused gharar, commerce would be impossible. Jurists thus carefully define the forms of uncertainty that cause an unacceptable level of gharar. For example, Ibn Rushd al-Ḥafīd states that gharar arises from uncertainty about:
- The specification of the object of the contract or the contract;
- The delivery date of the good and its quantity, quality, and/or price;
- The existence of the good and ability to deliver it; and,
- The remaining life of the good.
Each one of these types of uncertainty may occur alone or in combination with the others. Gharar thus functions as a copula for the analysis of specific epistemological, ontological, legal, and commercial issues.
Jurists from the other schools cite similar forms of uncertainty in their descriptions of gharar. Nevertheless, this overlap does not mean that all jurists have the same analysis for each transaction. For example, the sale of milk in the udder of an animal gives rise to debates about the existence of the milk being sold and about the knowledge that people could have about the milk’s quantity and quality. According to al-Sarakhsī, this sale is illicit because of uncertainty about the contents of the udder, which may contain milk of varying quality and quantity, or something else, like blood or air. Furthermore, the animal is constantly producing milk, so one cannot distinguish between the milk that was sold and the newly produced milk, which belongs to the owner of the animal. For him, these issues of uncertainty create an excessive amount of gharar. On the other hand, the Mālikī al-Bājī uses a basic statistical concept in order to tame this uncertainty. According to him, the purchase of milk from one animal has gharar because of the natural volatility in the quality and quantity of milk that it produces. However, he permits the purchase of the milk of a herd since there is qualitatively and quantitatively no volatility in the milk production of a large number of animals.
Contemporary Islamic Finance
Contemporary Islamic finance has developed, and continues to develop, in response to economic and social factors. Oil revenue and the burgeoning Muslim middle class have led to an increasing number of Muslims who want Islamic financial products and services, such as insurance, bank accounts, investment products, and methods to finance the acquisition of goods and services. Besides these economic factors, the development of Islamic finance fits into the larger agenda of Islamists who want to create a modern Islamic society. Writers on Islamic finance often devote a great deal of attention to elaborating claims about its positive economic and social effects. For example, Masudul Alam Choudhury argues that the ban on ribā prevents inflation, mobilizes capital and labor, and ensures the social equality of Muslims. Implicitly or explicitly, many of the claims of proponents of Islamic finance are made in opposition to Western financial systems.
The institutions and products of contemporary Islamic finance draw upon and modify the contracts previously discussed. For example, because of the prohibition against ribā, Islamic banks cannot have interest-bearing liabilities and assets. They thus create the liability side of their balance sheet by means of the muḍāraba. Islamic banks then invest these funds through Islamic contracts like the murābaḥa, salam, ījārah, and partnerships. However, because of their limited and unstable sources of funding, Islamic banks tend to invest in short-term assets.
Contemporary Islamic finance is also developing capital markets in order to assist individuals and organizations to raise capital and invest in different business ventures. For example, the ṣukūk, often called an Islamic bond, offers the risk and reward profile of conventional fixed-income products. However, unlike conventional bonds, which typically securitize interest-bearing debt, the ṣukūk securitizes assets and then issues participation shares to investors, who become owners of the assets. The assets that back a ṣukūk are Islamic-compliant contracts like the murābaḥa, ījārah, salam, and/or partnerships. Although these contracts are structured to generate cash flows that are like conventional fixed-income products, they and the ṣukūk are considered by many modern jurists to be compliant with Islamic law.
In addition to the ṣukūk, some jurists have issued fatwās that provide guidelines for investment in conventional equities. According to Dow Jones, which received the opinions of several prominent jurists, Muslims may invest in equities subject to two broad exceptions: (1) they cannot invest in firms that engage in prohibited activities like the production of alcohol, pornography, gambling, and conventional finance; (2) although the firms may use conventional interest-based financing, this financing cannot exceed certain financial ratios.
Because of the similarities between Islamic and Western investment products, some scholars have criticized Islamic finance as a form of regulatory arbitrage that creates more expensive services and products that simply mimic Western financial products. From this perspective, these Islamic products follow the letter of Islamic law but violate its spirit. Or to put it differently, one can view this regulatory arbitrage as a modern manifestation of the ḥiyal (legal stratagems) that premodern jurists discuss. The matter is further complicated by the fact that many of these Islamic financial products are designed to be subject to adjudication within American or British courts in order to enhance the appeal of these products to a wider and potentially non-Muslim customer base. On the other hand, proponents of Islamic finance argue that, as this field grows, the costs of Islamic products will become fully competitive with those of conventional products. In addition, they point out that the similarities between Islamic and Western systems reflect the fact that both must comply with the same regulatory requirements so regulators, financial institutions, and clients can understand both types of products and services.
In the early twenty-first century, Islamic finance has suffered some setbacks. This is in part because of the cloud of uncertainty that the global recession during this period has created. More importantly, the inherent structure of Sunnī law also creates uncertainty that makes it difficult to develop Islamic financial products that will be attractive to broad cross-sections of the Muslim community. Sunnī law has no centralized religious hierarchy to legitimize and impose new legal decisions. This means that the opinion of any jurist can challenge the legality of any transaction or financial instrument. In response to this potential source of uncertainty and instability, proponents of Islamic finance have adopted two general approaches to legitimizing their new products. First, they have formed several trade and self-regulatory groups to provide guidelines. Second, financial institutions generally employ a board of jurists for advice and fatwās to validate new services and products. In many cases, these jurists serve on the advisory boards of multiple institutions. This overlap ensures a greater uniformity of opinion and practice among institutions. The future success of Islamic finance will depend in part on the effectiveness of these two approaches in bringing legitimacy and stability to this growing industry.
Commercial Law
410 – 007
https://discerning-Islam.org
Last Update: 02/2021
